Lenders are increasing their exposure to German construction projects, while finance for UK development remains constrained
Financing property development can be a risky business, as one debt fund lender explained during a recent meeting. “The biggest risks are in the ground,” he said. “You never know what might be found once the digging starts.”
Contaminated sites, escalating material costs, overrunning works; the list of potential pitfalls is lengthy. To fund a development, the debt fund manager added, requires ongoing vigilance to ensure money is only released once milestones are reached.
Two major reports published recently show that while lenders in Germany are increasingly embracing that development risk, finance for construction projects remains tight in the UK.
In their relentless pursuit of deals, German real estate lenders are diversifying their portfolios and edging up the risk curve, according to the latest German Debt Project survey produced by the real estate business school at Bavaria’s University of Regensburg.
“Germany is building,” the report proclaimed. Taking results from its sample of lenders and extrapolating them across the wider German property market, the authors said that new business for ‘project developments’ was €32.2 billion in 2015, up 22.6 percent from the previous year. New lending to existing properties was higher, at €104.9 billion, although the year-on-year increase was only 18.9 percent.
Meanwhile, the latest edition of De Montfort University’s bi-annual report – the most comprehensive survey of UK commercial property lending – painted a very different picture. UK real estate loan books are becoming more homogenous as origination volumes dip and risk appetites shrink. Only 11 organisations were prepared to provide the authors with information on financing terms for fully pre-let UK development. At the end of 2015, 21 had done so.
Across De Montfort’s sample, development funding during the first half of 2016 was just £3.3 billion ($4 billion; €3.7 billion). During the whole of 2015, banks, building societies and insurance companies had provided £7.3 billion and other types of non-bank lender had added almost £1 billion.
It is worth noting that Regensburg’s figures relate to 2015, although the authors highlighted increasing diversification in lenders’ portfolios as an ongoing trend. De Montfort’s analysis shows that development finance was hardly abundant last year and has been less so during 2016.
So what does this say about the respective markets?
In Germany, domestic banks’ eagerness to fund development is driven by their need to deploy capital in an uber-competitive market. German property is seen as a safe haven and the country’s banks continue to allocate resources to financing it. As a result, loan pricing on vanilla deals is extremely tight. To generate some extra reward, lenders have to take extra risk.
In the UK, risk is a sensitive concept at the moment. The true value of commercial property is still not entirely clear after the contraction in investment activity in the run up to, and aftermath of, the EU referendum vote. The risk of funding development is too much for many banks.
Savills’ latest Commercial Development Activity report showed that development levels grew by 12.1 percent in September, the strongest rise for nearly a year and the first growth in four months. The UK’s clearing banks typically want to be seen supporting wealth-creating schemes, but risk-aversion is their main consideration at the moment.
“Banks are retrenching,” said the aforementioned debt fund lender, “nothing’s done with a bank until it’s done. Development finance is very capital-intensive for them.”
De Montfort showed that banks and building societies originated £18.2 billion of real estate debt in the UK during H1 2016. Of that, only 15 percent went to development (11 percent to residential, 4 percent to commercial). None of the £2 billion provided by insurance companies in the sample funded construction.
That leaves the alternative lenders. De Montfort’s first-half 2016 study showed that they originated £1.8 billion, of which 30 percent was weighted towards development finance. While debt funds are keen to bank developers, their volumes are limited.
Until the banks warm to development again, those aiming to bring schemes out of the ground will not be overrun with financing options.