Editor’s Letter: The tools for development

Daniel Cunningham

Financing property development requires an appetite for risk that relatively few lenders in Europe currently 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. One such is Cain Hoy, which recently teamed up with the Qatar Investment Authority to provide a £450 million loan for a core office scheme in London’s Canary Wharf. As Real Estate Capital went to press, news broke that the firm also provided £290 million for Lodha’s Lincoln Square residential project in central London.

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.

What borrowers want

A greater supply of development finance was one item on the wish-lists of borrowers at last month’s CREFC Europe and Loan Market Association real estate finance conferences in London. But the overriding requirement that borrowers have from their lenders is, simply, flexibility.

There is a growing notion among sponsors that greater headroom in loan terms is the most helpful thing a lender can offer to support investment strategies amid uncertain market conditions.

From the lender side of the debate, there is certainly a willingness to accommodate sponsors’ needs, although some concerns were voiced that there could be a slide towards a ‘covenant-lite’ culture, something lenders say they are determined to withstand. In the give-and-take between borrowers and lenders, loan covenants will be an ongoing subject of debate.

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