Liquidity shortfalls are likely to increase in the UK’s development finance market as a late cycle marketplace, compounded by the impacts of covid-19, makes lenders more selective.
According to a CBRE report, published on 22 April, development finance availability in the UK has contracted since the coronavirus outbreak, with fewer lenders open to new opportunities and most focusing on their existing loan books.
The pandemic crisis, however, exacerbated liquidity pressures already present in the market, the advisor said.
Nicole Lux, senior research fellow at Cass Business School and author of the latest Cass UK Commercial Real Estate Lending Report, which featured heavily in CBRE’s own publication, told Real Estate Capital in April that £25.5 billion (€28.32 billion) of construction loans had already been left undrawn by the end of 2019. Lux said: “This indicates to me that there was already a significant slowdown and delay in development projects in 2019.”
According to the Cass report, £22 billion of outstanding commercial development loans faced the risk of construction delays and defaults of construction contracts in the UK, with £15 billion of residential development loans facing losses due to lower unit sale prices.
CBRE said, subsequently, a fall in new development lending volumes, which would be reflected in outstanding aggregate loan books, was likely. Given this scenario, market participants would be looking out for whether that reduction would eventually reverse in part or become a new normal.
CBRE expected an increase in the cost of debt for borrowers as a consequence of a market with reduced liquidity. “As with any commodity, the scarcer it gets the more expensive it becomes,” said Andrew Antoniades, executive director and head of Lending at CBRE Capital Advisors.
Debt pricing, however, was considered a secondary issue compared to its availability, as was the case in the aftermath of the global financial crisis. Borrowers wanting to proceed with schemes, in some cases, were willing to pay higher interest rates – for them a cost of 400 bps could easily rise to 500 bps or more.
CBRE said scarcer development debt would come in tandem with demand for it. This would be due to a combination of developers and lenders being reluctant to take speculative risk, reduced demand in leasing and the impact of building site closures, according to the report.
Although lending has dried up at present, some lenders are still active. Per the Cass report, UK loan origination by lender type showed how debt funds and other new lending entrants provided significant capital to the market last year. The ‘other lenders’ category, mainly comprising debt funds, recorded a modest 4 percent rise in loan origination to £7.9 billion in 2019. Insurers provided £3.9 billion.
However, the debt sourced by non-bank lenders was not enough to offset the reduction in debt provided by the banks, said CBRE, which added this has ensured finance remained at a new lower norm. “The covid-19 crisis might not only crystallise this new lower level, but could also see it reduce further, at least in the shorter term”, argued Antoniades.
He added: “However, this is different to the GFC. The clearing banks are not as dominant as they were in the lead up to the GFC and there are established debt funds active in the market. How they will react, and what other new entrants may emerge, are significant unknowns. There is the possibility they could provide material liquidity to ‘fill the gap’ as they did in the last downturn.”
CBRE suggests lenders will be exercising greater caution, particularly in relation to speculative development or development carrying meaningful risks in this period of uncertainty. But, while lenders protect themselves, they are also aware of the potentially lucrative opportunities that have arisen.
The same applies for borrowers. While developers remain cautious, development finance may be made more readily available to schemes considered “future-proofed for post-virus new societal norms”.
Antoniades said: “Looking to alternative asset classes, we see increased interest and demand for science, laboratory and tech space. Pharmaceuticals and science-based businesses will need specialised new buildings and consequently there could be a rise in finance providers specialising in this.
“Timing is crucial for developers to emerge with the right asset for the market at the optimum time, while more cautious competitors have waited.”