Non-banks look to fill the development debt gap

The availability of development finance remains limited across Europe, although alternative lenders are aiming to fill the gaps.

The recent news that private real estate investor Cain Hoy has provided a £290 million loan to the developer of a major central London residential project serves as further evidence that alternative lenders are aiming to plug Europe’s development finance gap.

Cain Hoy wrote the loan to refinance an initial £78 million facility which it provided last October to Indian developer Lodha for the Lincoln Square scheme, plus to see it through to completion. In April, the firm teamed up with the Qatar Investment Authority to provide £450 million of development finance to Canary Wharf Group for the construction of a core office scheme – One & Five Bank Street in London’s Docklands – in a transaction which Cain Hoy managing director John Cole recently described to Real Estate Capital as a “proper property deal”.

The fact is that financing property development requires an appetite for risk that relatively few lenders in today’s European markets possess. The market for investment property lending is generally functioning, although most would agree that it is far from perfect. However, construction debt is far less prevalent and where it is found, leverage is set low and margins are set high. In short, the foundations for real estate development are shaky.

Naturally, the situation differs from country to country and sector to sector. The percentage of a scheme that is pre-let or pre-sold also determines a developer’s chances of raising finance. Generally, the funding available tends to be focused on the best schemes in cities like London and Frankfurt, brought forward by the most established sponsors.

At the other end of the spectrum, small-scale, high-value schemes including pre-sold residential in proven locations are attracting debt funds, which charge high margins for high returns. In the middle, there is less availability to talk about.

Much of this is due to bank reticence. Development finance carries with it a higher perception of risk, putting many projects outside of a traditional bank’s comfort zone. Regulatory capital treatment also dampens banks’ willingness to finance development. The UK’s slotting regime immediately allocates enhanced risk to development finance, and the standardised risk model looming across Europe due to Basel IV will only give bank lenders further cause for concern.

There are, though, developers out there eager to bring forward schemes and the scarcity of debt plays into the hands of alternative lenders, such as Cain Hoy. It is difficult to see banks’ attitudes to development finance changing dramatically any time soon, giving alternative lenders the opportunity to provide developers with the financial tools for construction.

The issue of development finance is discussed in greater detail in the June edition of Real Estate Capital. Your thoughts on the issue would be welcome: daniel.c@peimedia.com