Simon Champ, chief executive of specialist fund manager Newstead Capital, believes there is a growing opportunity to direct pension fund and insurance company capital towards financing small- to medium-scale residential development in the UK.
Newstead, which has so far raised £80 million (€91 million) of capital for its Newstead SME Real Estate Lending Fund, is aiming to raise as much as £300 million this year to invest in what Champ argues is an underserved niche of the UK real estate financing market – regional housebuilders.
The manager believes its fund, which has a five-year timescale to appeal to institutional investors, can deliver £1 billion of funding to support the development of 5,000 new, affordable homes.
“We are providing a conduit for long-term institutional investors to gain access to a market which, until now, has been out of reach,” he said.
In September 2022, Homes England, a public body that funds affordable housing, alongside local authority pension fund the Greater Manchester Pension Fund, clients of wealth manager Mattioli Woods and two Dutch charitable trusts, committed £80 million to the initial close of the fund.
Speaking last September, Peter Denton, chief executive of Homes England, and a former commercial real estate lender with BNP Paribas and Starwood Capital, described the commitment as offering SME housebuilders “a route to finance that may otherwise be unavailable through traditional means”.
Newstead has started deploying capital, Champ explained, with £15 million of loans closed and an additional £20 million in documentation. In February, it provided an £8 million loan to fund the conversion of a former hospital in the coastal town of Eastbourne into 53 residential units, in a mid-60s percent loan-to-gross development value financing. In its second deal, Newstead provided £7 million to a local developer for the conversion of a former brewery building into 21 apartments.
The two schemes are being developed under UK permitted development rights, reducing planning risk. Each involves the revamping of an historic building. “Both are attractive buildings, but they are starting to become eyesores in their towns,” explained Champ.
Writing development financing deals in today’s high-inflation environment requires underwriting a 10 percent contingency in sale prices, labour and materials, added Champ. However, he argued such loans generate attractive risk-adjusted returns for investors.
“When we set the fund up 1.5 years ago, the documents cited a return of 7.5-9 percent for our investors against a pool of smaller residential loans. That was prior to inflation. Now, we are seeing returns above 10 percent.”
Five-year horizon
While Champ acknowledges other specialist lenders are writing loans to SME developers, he argues Newstead’s strategy is unique in that it offers institutional investors a five-year investment in the niche sector.
“Others are lending to regional housebuilders. At the small end, some specialist platforms do it, although mainly through bridge financing. What’s unique is the fund structure. No-one else is trying to bring longer-term, stable money into the sector. No-one else has a dedicated five-year fund for housebuilding.
“Structurally, the private debt industry for medium-sized pension funds has not offered investors access to residential debt finance in a diversified, commingled fund.”
The five-year time horizon suits the needs of many pension funds and insurers, he explains, meaning loans are reinvested and likely to be invested three times in the five-year time frame. “In future, this strategy could lend itself to seven to 10 years.”
The strategy can appeal to smaller pension funds, rather than investors more likely to commit to large private equity fund managers, Champ said: “Consultants will drive larger pension funds to big names in the mainstream private credit industry where returns are lower. They are not rewarded for taking clients to niche strategies. So, for a new manager like us, we are happy to attract smaller tickets from smaller pension funds.”
Newstead is limited to writing loans to a maximum of 10 percent of the fund’s size, with a cap at £20 million. It also has a focus on affordability, targeting schemes in which units will be sold for no more than 25 percent over the average UK house price, which Champ says will ensure projects are pitched appropriately for their location.
“The fund is structurally incentivised to fund the building of affordable properties. We’ll always work with a local valuer to find gaps locally,” he explained.
Newstead is meeting with potential investors as it aims to grow the strategy, Champ said. “We are talking to local authority pension funds, some independent pension funds, international funds, and insurers. They are increasingly attracted to the equity-like returns on senior secured debt. We would love to have raised £300 million by the end of the year.”
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