In the third in our series on specialist lenders, Doug Morrison profiles a start-up operation on a quest to offer resi developers a blend of senior and mezzanine debt, with help from its US backer
Veteran property lender Robert Orr does not know who coined the phrase ‘stretched senior debt’, but if he has his way, the term will become synonymous with his latest venture, Titlestone Property Finance.
After a year in business, the Oaktree Capital Management-backed Titlestone can already claim to be a leading exponent of this recovery-era combination of senior and mezzanine debt, certainly in its specialist field of residential development.
Orr recalls that when he was approached by Oaktree in spring 2012 about launching a lending business, the proposed model was based on stretched senior debt in all but name. In fact, there was no such generic name for what they set out to do.
“Oaktree didn’t want to be a mezzanine funder because they didn’t like the risk of sitting behind other people,” he says. “They preferred the idea of being in charge but wanted to take a higher risk for a higher return than the senior debt people were taking. So their concept was to be a first-charge lender, but stretch it and take out the need to either put in so much equity or go to a mezzanine funder.”
By August 2012, Oaktree had launched Titlestone with Orr as chief executive. Providing ‘stretched senior debt’ has become their modus operandi and, he says, “part of the lexicon of business”. He adds: “With all things in life there needs to be a title put round it. We didn’t invent it, but we’re very grateful someone gave it a definition.”
According to Orr, whose career includes 15-year spells with both NatWest and Close Brothers, the name-tagging has been underpinned by a robust business model that has proved its worth to small developers still ill-served by the big banks. Whatever you want to call it, stretched senior debt is filling a gap in the market.
One-stop shop for borrowers
The perceived advantages to borrowers over traditional lending revolve around a one- stop shop proposition – one loan, one relationship with a single lender and one ‘blended’ rate of interest. So where a developer might once have gone for senior debt and mezzanine funding at 6% and 20% respectively, the borrower can now pay 11-12% to Titlestone for stretched senior debt.
“You repay a bit of senior and a bit of mezz at the same time,” says Orr. “You don’t have to repay all your senior debt at 6%, then wait for the last [property] sale to repay your 20% money. That’s why stretched senior works very well on multi-unit schemes.”
Titlestone’s loans range from £1.5m to £20m, for up to 70% of gross development value, while capped at 90% of cost. The firm only backs projects with planning permission and the typical payback period is 12-24 months. To date, £150m of facilities have been provided to 30 developer clients.
For Orr, a big motivation was to be able to build a lending business from scratch. The 10-strong team is relatively lean, but experienced. Key recruits include Simon Dekker from Investec and Nigel Jackson from Dunbar Bank – who both, like Orr, have been in the sector for 30 years.
But Oaktree’s presence is fundamental. Titlestone is one of several property-based investments from the US private equity firm’s €3bn European Principal Fund III (see panel), whose 10-year horizon suggests Orr can lay the foundations for a lasting business.
There are benefits, too, from what Orr calls the “loose association” with another Oaktree-backed business, Countrywide, the estate agent that operates across Titlestone’s favoured patch of southern England.
Titlestone is unlikely to venture elsewhere, not least because Orr harbours doubts about the recovery prospects in housing markets further north. Yet at the same time he is sceptical about the prevailing boom in prime London residential and that market’s reliance on off-plan sales to overseas buyers. He says his caution towards the latter goes back to his time at Close Brothers.
“I can still remember when £1,000 a square foot seemed expensive in London and I’m slightly nervous about why £3,000 is the going rate,” he says. “We also like the idea of a UK buyer with a UK mortgage buying our developers’ products, rather than having to rely on overseas buyers, be they rich Russians or from the Far East.”
Targeting UK as well as overseas buyers
Orr suggests that the flow of capital from overseas buyers is always susceptible to political events or taxation changes back home. “If they took a pause for breath for, say, six months, what would that do to the [UK] market?” he asks, before adding: “We are very happy if our developers want to go to the overseas market, maybe off-plan sales in the Far East. But we always want to fund schemes that would still appeal to the UK buyer if that overseas market wasn’t there.”
That leaves Titlestone promoting its version of stretched senior debt for schemes worth up to £1,000 per sq ft across suburban London and a large section of the more prosperous parts of provincial England. Orr claims there is little direct competition to Titlestone in its chosen territory and lending criteria, but suggests “mezzanine funders will have to reinvent themselves” if developers continue to forsake traditional lending for stretched senior debt.
For the time being, Titlestone has something akin to a first-mover advantage and Orr is making the most of it while he can. He hopes the loan book will top £350m over the next two years, which would no doubt stoke speculation about an Oaktree exit from its investment in Titlestone so that it could maximise its returns.
“My job is to build a brand that’s associated with residential development,” Orr adds. “We’d make no secret of the fact that at some point we’d like Titlestone to be an appealing brand that someone may want to pay more than the value of the loan book for to get their hands on it. But a year after launch, we’re more interested in the first part of the journey than the end of it.”