Handful of loans hint at return of speculative UK development finance, writes Paul Yandall
As far as the London 2012 Olympics went, it wasn’t the most golden of days. Team GB’s 4x100m men’s quartet had again dropped the baton, three-time world champion BMX rider Shanaze Reade failed to make the podium, and the sailors and boxers could only bring home silver and bronze.
However, across town at King’s Cross, developer Argent’s finance team was in raptures. “It was euphoria!” says finance partner Jim Prower, recalling the events of 10 August that year. Argent had just secured the only speculative development finance in years from Eurohypo, a £71.5m loan to develop its One and Two Pancras Square buildings at King’s Cross.
“What was doubly gutsy for them was that they were doing it and we hadn’t at that stage let anything to anybody,” says Prower.
If anyone believed that deal three years ago signalled the return of a significant development financing market, the intervening years proved them wrong.
“Funding for development in the past five years can best be described as a patchwork quilt,” says Chris McMain, transaction associate at JCRA Laxfield. The real estate finance adviser recently started collecting data on requests for development financing.
McMain adds: “Clearing banks are still seen as the main funding source for £10m- £50m, bread-and-butter business. A variety of debt funds and private capital providers have responded to the opportunity in whole loan residential funding and bridge financing. But at the larger end of the scale, a post- crisis recognised market is still to emerge.”
The market for commercial development finance has been challenging, to say the least. Last year, only 17 organisations were willing to lend against fully pre-let developments, according to De Montfort University’s Commercial Property Lending Report for the UK, published in May.
Just seven were prepared to back 50% pre-let/50% speculative schemes. And only five lenders wanted to lend against solely speculative commercial developments.
London leads the way
However, while such finance remains rare, it is available, and the turn-around has come first, as could be expected, in London. The recent purchase of 80 Fenchurch Street in the City of London by Switzerland-based Partners Group for a £200m office scheme is, for now, a purely speculative venture. But such is the demand for good City office space, it’s unlikely to stay that way for long.
“What we have noticed in the market, given the very low vacancy rate for class A office space, is an increasing number of tenants looking to pre-let space two to three years ahead of their actual need,” says Claude Angéloz, co-head of private real estate at Partners Group.
Partners plans to borrow up to £150m to develop the scheme and has put two proposals to lenders: to fully finance a purely speculative scheme, or to back the scheme if a pre-let is secured before construction begins in 2016.
“I was quite positively surprised to see banks were willing to provide us term sheets for the first option,” says Angéloz. “That is, purely speculative without knowing whether we’ll ever get a tenant, at what rate and of what quality, from now to end delivery, stabilisation and then sale to a core buyer.”
Both options are still on the table but given the better terms available for a pre-let prior to development, and Partners’ confidence in securing a tenant, the second looks more likely.
JLL and Knight Frank are the scheme’s leasing agents. “We’re very confident about 80 Fenchurch Street and other pre-letting opportunities in the City, as there is not a great wealth of very good sites there,” says Dan Gaunt, partner and head of City agency at Knight Frank. “There is a decent level of pre-lets; it’s not exceptional, but is good and solid. Whoever selects the best sites will be rewarded over the next 12 to 18 months.”
Where is the demand coming from and how vigorous is it? “The corporate world has moved,” says Gaunt. “Companies now have more cash on their balance sheets, and more shareholder confidence to make bold decisions about property, merging or taking over other businesses, marrying up two businesses and deciding they want to put them under a single roof.”
An example of the type of corporate activity that could drive demand for pre-lets in the near future is the recent $4.1bn merger of global insurance companies US-headquartered XL Group and Bermuda- based Catlin Group. Both have offices on Gracechurch Street in the City.
“There’s no requirement there that we know of, but following the merger, you would think they will say: ‘We’re going under the same roof to share the same culture and values’,” says Gaunt. “I think we’ll see more of that kind of corporate activity, and more and more requirements.”
For major banks, securing a pre-let is still a key ingredient in making development finance possible. “We just like to see projects that are appropriately de-risked,” says John Feeney, managing director and global head of corporate real estate for Lloyds, which is lending on several big developments being brought forward.
“So, if it’s residential we look for pre-sales, if it’s commercial development we look for pre-lets. We want to see those features in place, plus, of course, the quality of the sponsor and contractors they’re working with; the location and appropriateness of the asset for the local market; and all those things a normal underwriter would look for.”
The dearth of good City and West End office space will lead to a commercial development ‘mini-boom’, says Feeney. “We’ve been preparing for it for the past year, hence we’ve set up our developers team, entirely focused on working with the big developers. So we’ve been changing our business to adjust to this opportunity.” Graeme Afille-Cook leads the team.
Looking beyond the capital
That will lead, inevitably, to more development lending – and, hopefully, not just in London. Feeney adds: “Manchester is probably the hottest market outside London; Edinburgh’s starting to see a fair bit more activity and there are hotspots around the country, places like Cambridge, where there’s a lot of housing activity going on and a bit of commercial development too.
“We’re increasingly seeing some really good opportunities in the regions. The challenge from a banking perspective is that we like volume, which London gives us very easily because every deal is big.”
Even among the major banks there is a wide spectrum of lending behaviour when it comes to development. JCRA Laxfield’s McMain says the firm was recently mandated to raise development finance for a central London project with a senior funding requirement of more than £100m. The scheme involves high-quality housing with a large speculative commercial element.
“We were surprised how disparate the responses were from the lending market, even within the same categories such as UK clearing banks, where risk appetite and pricing varied dramatically,” says McMain.
“We received strong interest from UK, US and Asian lenders and did find some UK lenders prepared to lend and hold more than £100m, despite anecdotal evidence suggesting otherwise.”
So the return of speculative development finance is starting to make headlines, and, along with the weight of equity seeking investment opportunities, is enabling a raft of key London sites to be brought forward, including the White City and Silvertown projects.
However, such finance is still almost exclusively reserved for experienced developers building in the best locations, with realistic development appraisals – rightly so, many would say.
Max Sinclair, head of UK commercial real estate at Wells Fargo and Argent’s backer in 2012 when at Eurohypo, says new banking regulations since the credit crunch have made development finance difficult, though not impossible, for UK lenders.
“It is much more difficult to put into place the sort of development financing we did at King’s Cross. It’s not something one rules out but a lot of capital requirements need to be satisfied today and that wasn’t the case back then,” says Sinclair.
Prior to the King’s Cross deal, Eurohypo’s real estate financing team had not backed a scheme speculatively since the Heron Tower in the City in 2006. Under Wells Fargo, it hasn’t done so since King’s Cross, but has made a few loans on de-risked developments, such as to Angelo, Gordon last year for a West End residential scheme.
King’s Cross an early winner
“We identified the Argent team and King’s Cross as one which was going to be a huge success,” says Sinclair. “If the world had not had the financial crisis, we may well have put that facility in place before 2012, but everything was just a little bit delayed.”
However, that deal still took 18 months to negotiate, says Argent’s Prower. “There was only one door to knock on then, but in many ways that was good because we knew who we had to see. I can still count on one hand the people who will even consider development funding or speculative funding at a reasonable rate, it’s such a narrow field.”
Last month, Barclays provided £215m for further retail, leisure, office and residential space at King’s Cross.
Royal Bank of Scotland recently backed the building of Four Pancras Square at King’s Cross with a £100m loan, although that financing is ‘cross-subsidised’, says Prower.
Other funding arrangements are in the works with Wells Fargo. Wells converted its One and Two Pancras Square loan into an investment loan – as close to a perfect exit from a development as a bank could want.
So what do developers need to be able to convince lenders to back them? “There are lots of factors, but at the end of the day it’s down to their assessment of the sponsor,” says Prower. “With a big balance sheet, good track record and a development in the right place, you’re in with some hope.”
Japanese banks tune into BBC programme
The £1bn redevelopment of the BBC’s Television Centre site in west London is set to begin in 2017, after developers Mitsui Fudosan and Stanhope finalised planning permission in March, sold an equity stake to a Canadian pension fund, and closed on £350m of development finance in June.
Mitsui Fudosan owns 75% of the scheme and last month announced that Alberta Investment Management Corporation now owns the other 25%, with Stanhope remaining development manager. Sumitomo Mitsui Trust Bank and Summitomo Mitsui Banking Corporation were appointed to provide debt.
An initial slice of the £350m of development finance has been drawn for the cost of the site acquisition, with the rest to come over the next three years as the site is developed into 430 homes, 520,000 sq ft of offices — partly pre-let to the BBC — and a boutique hotel and Soho House club. The facility is at a relatively low loan-to-cost ratio of just under 50%.
Stanhope appointed CBRE Capital Advisers’ debt advisory team last year to advise on raising development finance. The mandate involved contributing advice on the financial model, preparing the debt information memorandum, running the beauty parade to chose the banking partners, and advising on documentation and closing.
Crossrail’s eastern promise puts Silvertown project on track
The power of Crossrail — London’s new cross-capital fast rail link, due to open in three years’ time — combined with the capital’s powering economy and economic shift to the east, are making one of east London’s largest sites finally possible to develop.
Silvertown, some miles east of Canary Wharf, comprises a 62 acre, largely cleared site around a massive former flour warehouse, which has stood empty for a generation. What’s changed is that the land will soon be just a few minutes over a bridge from the new Crossrail Custom House station.
In April, the Silvertown Partnership, a joint venture between Chelsfield Properties, residential specialist First Base and Macquarie Capital, won resolution to grant planning permission for more than 7m sq ft of office, residential and leisure development. “We will offer value with connectivity,” says Simon Webster, Silvertown’s managing partner.
The partnership has appointed Macquarie Capital and CBRE Capital Advisers to look for an investment partner that can bring £500m of capital to build the 1.8m sq ft first phase, at the western end of the site.
“We’re working on two things: getting in place all the agreements to get full planning permission, which we anticipate will be granted this autumn; and exploring how we fund the project,” Webster says.
The partnership aims to complete a large part of phase 1 by the end of 2018, when the station is due to be open. It’s an ambitious amount of development for a single phase, including transformation of Millennium Mills into 500,000 sq ft of incubator office space, 300,000 sq ft of new office space, plus housing. But, says Webster: “We wanted to have critical mass and develop the public realm, creating ‘a piece of city’. The scheme’s quality will raise the bar of what’s developed in east London.”
The reason it will work as a commercial location, he argues, is that “we’ll let at good value rents, well below costs closer to central London. Smaller technology companies have been establishing in Shoreditch and rents are rising there. We can offer a price point below in a building with high ceilings and big windows, where they can co-mingle with other firms.”
Macquarie and CBRE will be casting the net far and wide: “It will come as no surprise that there is potential from Far Eastern investors, but also ones from North America and Europe; we are keeping an open mind,” he says. “It’s all about timing; and it is the right time.”