An uptick in liquidity of development finance in the UK looks likely to fall far short of demand, as lenders remain cautious when it comes to construction schemes.
Although new research from CBRE Capital Advisors suggests developers will benefit from stable, or slightly improved, availability of debt – in line with recent findings from the De Montfort University report – the consultant argued that many lenders remain unwilling to take advantage of development lending’s risk-return opportunities.
In the latest De Montfort report, for H1 2017, 23 percent of all new origination went into development finance, although margins increased over the period. CBRE’s latest research shows the spread between development and investment loan margins has increased, particularly for speculative projects.
“There is still aversion in the market. Traditionally, banks have been the most active players, but with slotting regulation and lower leverage points, they find it harder to finance developments, especially if they have not been materially de-risked,” Andrew Antoniades, head of debt investment advisory at CBRE Capital Advisors, told Real Estate Capital.
“Debt funds and alternative lenders are filling the gap to a degree, but they cannot replace the overall liquidity that the banks no longer provide, although there is still a huge need for development finance,” Antoniades added.
According to its research, CBRE expects lending volumes to be stable, or increase slightly, across the development market, be that for pre-let or speculative schemes, in the next 12 months.
Whereas a year ago CBRE expected availability of speculative development finance to drop, it now expects it to be stable, or increase slightly, albeit from a lower base than in 2016. “Any increase in overall liquidity for development will derive from selected funders who may enter the market on an opportunity driven basis where the returns are sufficiently attractive,” the report highlights.
In the meantime, development finance remains selective and is biased towards the best schemes and sponsors, which means many schemes with good fundamentals “might struggle” to source finance if they do not have the right mix of strong sponsor, location and pre-lets or pre-sales, Antoniades said.
Scale is an issue. The report highlights that construction finance for larger schemes is scarce and, more than ever, predicated on relationships with the developer or sponsor. Most traditional lenders find it challenging to write and hold tickets between £50 million (€56 million) and £100 million to a single scheme, while providing more than £100 million becomes even harder.
The largest schemes that need between £300 million and £400 million of senior debt, therefore, have a problem, CBRE added. The £1.3 billion St John’s Neighbourhood development in Manchester, currently funded through the North West Evergreen public fund, illustrates this case.
“Arguably, the scheme’s only sin is its size. If no-one fills these gaps then transformational schemes risk delay, being scaled back at best or cancelled at worst,” the report states.
As development schemes requiring higher levels of leverage, up to 75 percent loan-to-cost, do not fit the risk appetite of banks, alternative lenders are becoming “increasingly needed” for such structures, Antoniades said.
“We need to have more creative lender types and probably more capital available to lend in a flexible way to meet the demand,” he added. “Getting higher levels of leverage to make schemes fully funded is still a challenge, more so than the cost of debt. I see the issue being more availability than affordability of development finance.”
The report notes the potential for some overseas investors to see the gap for development finance in the UK. Peer-to-peer lenders are also an “important and vital” feature of the development finance market, having seized the gap in the market. However, these niche players provide debt financing to smaller schemes at a high cost, taking higher levels of risk compared with traditional finance.