Analysis: Turning to debt

With an increasing appetite to provide debt capital alongside equity investment, property companies are the latest players to enter real estate lending, writes Lauren Parr.

At Savills’ most recent Financing Property presentation, hosted last month in the City of London, property companies were singled out as the latest type of organisation to enter the real estate lending space.

Lenders in the market had heard noises of propcos – traditionally equity investors and developers in the market – moving into the debt side of the business, and the whispers found their way to Savills’ valuation director, Nick Hume, who compiles the list of lenders willing to nance UK real estate, which is usually ashed up on screen at the annual event.

“Since the downturn, there have been a couple of propcos lending to other purchasers of property on a selective basis, but it could be a growing area of the market,” says Hume.

Hard evidence of propcos turning lender is lacking, although there are those in the market who suggest that there are equity players seriously considering the bene ts of lending, in line with the increasing diver- si cation of the lending market. In recent years, alternative lenders such as insurers and investment managers have encroached on traditional banks’ space, attracted by the wide spread between the all-in cost of money and the UK all-property equivalent yield.

From a propco’s perspective, lending would be a “natural extension” to equity investment, suggests Victoria Hill, senior director at CBRE Capital Advisors, who structures debt on behalf of borrowers. “The real estate market has become more debt savvy. More people are talking about debt as an investment medium but without the jargon and better understanding,” she says.

“There is recognition that if you combine real estate investment expertise with lending expertise in the right groups of people you can enter the market relatively easily.All you need is a clear and unambiguous agreement drawn up between a willing lender and bor- rower,” Hill points out, as commercial lend- ing between corporates is non-regulated.

Such deals are typically opportunistic, although more propcos are beginning to seek deals in the expectation that potential business will increase as clearing banks avoid complicated nancings.

“There is a distinct lack of clarity regard- ing the appetite of some mainstream lenders in what is an increasingly uncertain political environment in the UK, which brings with it a ight to track record as a prerequisite and relationship lending,” adds Hill.

In the past six months, the number of enquires she has received from Prop- cos looking to lend has risen. “The ques- tions started as early as a year ago around whether we saw clients struggling to nd nance,” says Hill, adding that her usual answer to them is that there are always rms that struggle to get certain assets nanced “as a good investment proposition doesn’t necessarily make a good lending proposition, given the di erent risk-return requirements”.

“At the end of a meeting, borrower clients would pick our brains on lling a gap in the market themselves, or would tell us they had already extended money to a party they knew on a debt basis,” Hill adds.

One piece of anecdotal evidence is the nancing of the purchase of a plot of land adjacent to a joint venture’s asset, nanced by one of the joint venture equity partners because bank funding for the land purchase could not be sourced.

Some large, long-term property hold- ers have cashed in on assets and may be sitting on cash. “They’re not comfortable paying high [investment] prices and are looking at balancing their books between equity and some debt investments,” says Brian Bartaby, founder and chief execu- tive of Proplend, a peer-to-peer lending platform for sub-£5 million commercial real estate loans.

Propco lenders have emerged where the risk/return pro le of either a mezzanine piece or a whole loan is perceived to be more attractive than the equity proposition the investor was originally considering.

“Propcos that run a sideline in lending tend to operate mainly on the residential development side, which o ers the poten- tial to turn high single to low double-digit returns into mid double-digit returns,” says Bartaby.

Lending returns are not dissimilar to pure core CRE on a risk-adjusted basis. The worst-case scenario is that the propco lender ends up owning the property should it need to enforce, through which it could still achieve a healthy return.

From the sponsor point of view, there are suggestions that some have been reluctant to borrow from propcos in the past for fear of giving away their investment tactics or concerns over whether the lender might eventually try to take the property into its own hands.

“There is a distinct di erence between this and a loan-to-own approach,” argues Hill. “This is about a propco being comfortable with the risk it’s taking as a lender, whilst having the manpower and capability to execute plan B if an asset came back to them.”

Propcos’ familiarity with the underlying real estate which collateralises loans could result in a more pragmatic view on loan default and the prospect of taking ownership shifting patterns of a property.

“This type of lender really does differentiate itself and could bring true diversity to borrowers,” says Hill.

There are no suggestions that propcos are likely to set up direct lending platforms. Some in the market suggest that they will form part of a growing long-term trend in which debt as an investment medium increasingly sits alongside direct and indirect investments within property portfolios.

The propco lending market remains in its early stages. Hill counts around ve deals by propcos in the past few months that “address latent borrower appetite to take debt on assets that are more di cult to nance”.

However, she adds: “It’s past being purely opportunistic. Not only will propcos con- sider deals if they fall into their laps and make sense, but they are actively looking for them, both in the UK and Europe, pro- viding they are happy with the jurisdiction and property fundamentals.”

For the time being, those propcos that provide debt are likely to do so on an ad hoc basis. “They generally haven’t approached this from a top-down strategic point of view; they assess each opportunity on its own merits on a deal-by-deal basis,” Hill says.