The property finance market that serves the auction sector has been reshaped in recent years – and there is some good news for the owners of assets with short-term leases, writes Stuart Buchanan
In the course of working in the property finance sector for more than 25 years, I have seen the attitude of lenders to property investors change substantially.
Until the financial crash, if a bank liked a client, it would work hard to structure finance for whatever type of property transaction the client was trying to achieve. To use a medical analogy, banks were general practitioners.
After the crash, this approach all but vanished: lenders now tend to be specialists and the days of the one-stop funding shop have gone.
It means that the real estate lending picture is now extremely fragmented, with lenders looking to specialise by lending on specific sectors, rather than across the whole market. Borrowers can spend a lot of time barking up the wrong tree if they aren’t aware of each lender’s specialism.
However, the positive flip-side to this is that lenders are now taking a varied approach and will look at situations that the “vanilla financing” of the past would not have encompassed. A good example of this is commercial investment properties with fewer than five years to a tenant’s break option or lease expiry. The sweet spot for lenders was income secured on long leases, with five years often being the minimum term they would consider.
However, the length of commercial leases that are granted across all sectors – perhaps with the exception of leisure assets – is now reducing. So if lenders are going to “get into the game”, in many situations they are going to have to be more receptive to assets secured on short-term leases.
During the past year, a number of lenders have started to lend on both single-tenant short leases as well as multi-let short leases. Loans against shorter leases are normally structured to amortise to a percentage of the vacant possession value of the property. This percentage varies between lenders.
Borrowers should also be aware that in today’s lending environment what constrains finance for investment properties is not normally the loan-to-value covenant. It is the debt service covenant – which can vary enormously – that caps the majority of loans. Debt service covenant ratio is the ratio of cash available for debt servicing to interest and principal payments. It is a popular benchmark used in the measurement of a potential borrower’s ability to produce enough cash to cover its debt payments. The lower this ratio is, the easier it is to obtain a loan. Breaching a debt service covenant can, in some cases, be an act of default.
A recent example of debt service coverage at work concerned a client I was advising on the refinancing of a portfolio of commercial investment properties in London. Lender A offered terms with a maximum loan of £5.5m, while – for the same properties and rental income – lender B offered terms for a £9.8m loan. It’s hard to believe that one loan could be 78% more than the other on the same portfolio, but it shows how policy on debt service covenants influences lending.
This outline summary of several clearing banks and a challenger bank based on my experience of new-to-bank clients illustrates some of the differences in lending policy (see below).Sometimes it is not only between lenders that loan terms can vary. It can also happen between geographical areas covered by the same lender organisation. Lending appetite can change depending on the local office culture, how much business comes through its doors and even how close to the end of their financial year it is – one manager has comfortably hit their target, while another still needs to draw down loans to meet their objective.
The development finance sector is possibly even more fragmented. There are around 50 lenders offering various types of development finance. Each lender has a set lending policy which has a loan capped at a percentage of loan-to-cost and a further cap, which is capped at a percentage of gross development value. The loan-to-cost ratios vary between 50% and 90% and interest rates are linked to the level of equity the developer is putting into the deal, with rates varying from 3.25% to 12%.
Lenders can be very subjective regarding the actual developments themselves, with identical risk lenders sometimes lending or not lending based upon their personal opinions of locations, property type or even the design of what is being built (see table above).
With so many different options and constraints on finance, it can be difficult to find exactly what a borrower requires without specialist advice to make the funding picture clear. This is particularly true for the private investors who are increasingly entering the commercial property sector for the first time and realising that having the right structured finance is key to building successful portfolio holdings.
Differing attitudes to debt service coverage
| Tenant Covenant | Margin | Debt service based on £100k rent | Interest only | |
| Lloyds | Weak – Strong | 2.6 – 4% | £700k – £900k | No |
| Santander | Medium – Strong | 2.5 – 3% | £850k | Yes |
| Barclays | Medium+ – Strong | 2.75 – 3.5% | £750k | Yes |
| Metro | Weak – Strong | 3 – 4% | £900k | Yes |
Differing Attitudes to Development Finance
| Max loan to GDV | Max loan to cost | Interest Rate | |
| RBS | 55% | 60-65% | 3.5-4.25% |
| Paragon | 65% | 80% | 6-7% |
| Octopus | 70% | 80-90% | 10% |
Stuart Buchanan is a director of specialist property lending adviser Acuitus Finance
Time to streamline property lending
The private investor market is a hugely important and substantial part of our business, which includes NatWest and the Royal Bank of Scotland as well as our private banking brands Coutts, Drummonds, Child & Co, and Adam & Company. As a result, we are constantly looking at ways to improve our service to these customers, keeping pace with technological changes and trying to learn from sectors where the customer’s experience has been transformed in recent years.
We are constantly seeing changes in the consumer industries. From booking a taxi and doing the weekly shopping to sending a gift to a friend and having a fresh meal delivered to your door, technology is making the customer experience easier and more convenient. While lending money will always involve more complexity, there are common elements of all these processes that we can adopt to improve the experience for our customers.
The retail banking sector has already made great strides with online platforms. Transactions that in the past would have involved a visit to a branch and a three-day wait are now being made via a few clicks on a mobile phone, with the funds in the payee’s account almost instantaneously.
Commercial banking has perhaps been somewhat slower to exploit new technology, in part owing to the greater complexity involved. However, even in this sphere there are ways in which processes can be streamlined. NatWest recently launched an online lending platform that will allow SMEs to borrow up to £35,000 in a process taking around three minutes. Customers can find out instantly how much they can borrow, and the money will be in their accounts within 24 hours, cutting days off the old process.
At heart, the property industry is a traditional one, and many of the processes involved in buying, selling and financing property have been largely unchanged for many decades. These can be protracted, and are often very similar for a private investor seeking to borrow against a single investment asset as they are for a corporate investor with far more bespoke and complex requirements.
It is our strong belief that this should not be the case, and with this in mind we have spent the past six months taking the entire process apart piece by piece and stripping out anything that is not vital to delivering an efficient service for customers with adequate protections for both parties.
Since December we have been running a pilot programme out of Liverpool to test the end-to-end process, and in January we extended it to London. The pilot covers customers who want to borrow up to £2m, and offers products for commercial and residential investment as well as residential development. As a result of this work, we are confident that we can deliver funds to customers significantly more quickly.
With the customer providing the relevant information on the asset or scheme in question as well as the management team’s track record, the customer will get a credit-approved decision at the end of a call that should last no longer than 45 minutes.
As part of our planning, in January I met with 13 of the top auctioneers in the country to share our plans and to hear their views. The property auction market closed almost 25,000 deals last year, attracting £4.5bn in investment from private investors and small property companies.
As such they are masters at executing efficiently and they greeted our plans with enthusiasm, while cautioning that the legal and valuation work involved in due diligence was always going to be the limiting factor in improving efficiencies. Part of the new process therefore involves customers using their own solicitors in certain circumstances, while we have selected a panel of nationwide surveying firms that have committed to a maximum 10-day turnaround.
Our guiding principle for this project was to take the pain out of property finance. With a commitment delivered in 45 minutes, private investors and SMEs can spend their time doing what they do best – investing in and building the homes we need, the offices we work in
and the places where we relax and play.
Paul Coates is managing director for real estate finance, NatWest
