In recent years, the UK’s largest property companies have had little difficulty in obtaining debt finance, leveraging their strong balance sheets to fund their often prelet or pre-sold development activities cost effectively.
However, when it comes to speculative schemes being undertaken by the lesser recognised tier of developers, increased regulations and capital requirements on banks that have imposed additional costs on lending have made it necessary for this group to look increasingly at alternative sources of capital.
Non-bank alternative lenders are not subject to the same costs that have been imposed by the introduction in 2013 of “slotting” on traditional lenders, and have therefore stepped in to fill the gap for speculative development finance that the banks are largely avoiding, driving an evolution in the lending landscape.
Initially, the majority of alternative lenders were focused on residential or residential-led schemes in London and the South East, but as the sector matures, this segment is increasingly lending across the UK and funding a number of purely commercial schemes. Alternative lenders now cover the full spectrum of development finance projects, from senior debt for a refurbishment project, to mezzanine finance for a speculative commercial development.
Developers are particularly attracted to the more tailored financing solutions offered by smaller debt funds, which are quicker in execution and more flexible than traditional banks restricted by set credit criteria. The ability to offer a whole loan solution at up to 85% loan to cost is a key competitive advantage for debt funds as it provides borrowers with certainty of funding, while reducing the execution risk, timescales, cost and complexity of a more “structured” solution with multiple lenders. The investors, on the other hand, take comfort that these loans are, on average, never more than 65% loan to gross development values.
This increased breadth of funding options for developers is beneficial for the broader real estate market; diversity of lenders can contribute to financial stability by spreading risk and exposures across a greater range of investors, while increased competition has had the knock-on effect of reduced pricing.
However, there are new concerns looming that concern rising site and construction costs, and potential overheating, particularly in the central London market. The uncertainty of Brexit will continue to linger until the end of June, although there has been little evidence of a slowdown in loan enquiries as most developers do not have the luxury of being able to sit on sites that are ready
to develop.
Looking ahead, the development finance market is likely to continue to benefit from increased liquidity driven by alternative lenders, as new entrants come to the market – including a new wave of peer-to-peer lenders – and established alternative lenders deploy newly raised debt funds. Bank development lending appetites are likely to continue to be severely constrained by regulatory capital issues, with clients largely limited to large-scale REITs and major developers.
I would expect that the increased liquidity entering the market is likely to accelerate the trend of lenders looking to the regions to source deals and should further increase the availability of speculative development finance. The prevalence of mezzanine development finance is also likely to increase as investors move further up the risk curve to meet their return requirements.
Despite the pricing pressures caused by additional liquidity, the enduring regulatory constraints on banks balanced against investor return requirements for alternative lenders should put a floor under pricing for development lending – supporting the longevity of the cycle.
Harin Thaker, chief executive, Aeriance Investments
