Five reasons to finance UK residential developments

While certain areas of the market continue to struggle, debt providers are increasingly drawn to the sector’s fundamentals, which offer an oasis of opportunity in the country.

As recent headlines have indicated, UK residential developments are proving a magnet for property lenders attracted by positive fundamentals in the sector.

While London presents a mixed picture – with affordable housing demonstrating far better liquidity than homes valued above £1 million (€1.12 million) – the regions are attracting finance from several specialist lenders. This week, for instance, investment firm KKR and finance provider Urban Exposure formed a joint venture to focus on UK regional housing lending, which highlights the appeal of the sector.

Here are five reasons real estate lenders should consider UK residential developments now:

1. Greater supply. The UK government is aware of the shortage of housing in the country and wants construction of new homes to rise to 300,000 per year. In 2017, builders registered plans to start 160,606 new homes, according to the National House-Building Council. This is up 6 percent from 2016 and the highest number since the start of the financial crisis in 2007. Lenders should be aware of this uptick and notice that the phenomenon is UK-wide and not just a London effect.

2. Shortage of debt capital. Some market players have highlighted that debt finance for residential developments is scarce, particularly in the regional markets. While traditional banks have been retreating from the development finance market since the financial crisis on the back of regulatory pressures, several debt specialists, such as Urban Exposure and Maslow Capital, are already capitalising on demand from local developers to expand their loan books. It is also true that UK clearing banks are tackling the lack of development finance, but these banks tend to rule out speculative schemes.

3. Pricing premium. Development loans for residential assets offer attractive margins at a time when lending competition in the senior space is keeping pricing tight at 1.5 percent on average, according to CBRE’s Q1 2018 debt map. Meanwhile, loans for residential developments can range between 5 percent to around 9 percent, depending on the risk profile of the project. To achieve this premium, however, lenders need to be prepared to take on construction risks.

4. Build-to-rent boom. Britain is seeing record-breaking investment in the build-to-rent sector. In 2017, investment in this space totalled £2.4 billion, representing a 22 percent increase year-on-year, according to CBRE. The substantial growth in investment has been attributed to strong flows from the US and Canada, where investors are familiar with the equivalent multi-family model in their domestic markets. Lenders are already capitalising on the enormous interest in the sector, especially when it comes to residential spots with good commuting links.

5. Repurposing opportunities. The redevelopment of obsolete or underperforming real estate into residential assets could be capitalised on by lenders. For example, retail parks face an increasingly perilous future – so turning some sites into residential-led developments could mitigate downside risks, such as downward pressure on rental income, while delivering sustainable investment returns over the long term, notes Andrew Appleyard, head of specialist real estate funds at Aviva Investors. Such redevelopments could bring deals for lenders – if the asset has the right sponsor.

These factors could well create a perfect storm for opportunities in the residential development space. It will be interesting to see if debt providers capitalise on it.

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