Development finance drought to continue for years

By Bridging Loan Directory -

Borrowers and lenders do not expect the drought in development finance to recover for up to five years and will increasingly need to put more cash into deals and come up with more creative solutions to the liquidity crisis, according to a wide ranging report.

The IPF and Association of Property Bankers’ joint report, Outlook for Development Finance in the UK, interviewed 29 lenders and 24 leading developers between the end of July and September.

The report found that among the lenders 16 banks are working on development finance transactions in the UK, of which 11 have already concluded deals in 2011. In aggregate the 16 banks expect to issue over £2bn of finance by the end of 2011.

Transaction sizes range from £250,000 to £125m, and 13 banks are lending regionally. Finance is available across all the main sectors, with office and retail predominating.

The report finds however that borrowers have accepted there is a “new world order” and this is likely to remain for the next three to five years with development finance unavailable at attractive rates. As such “in order to survive” business models will have to be adapted.

The most important criterion is to have available cash and to this end developers are likely to increasingly look to be rated to have access to capital markets.

The report finds that few vendors are keen to accept a bid that is subject to bank finance.

It adds however that the economic crisis has brought with it welcome changes. It writes: “Some developers who acted prudently prior to the crisis found they often lost out on land and property acquisitions to those using highly leveraged finance. A number of these heavily indebted developers are either in trouble or no longer around – and the same is true of some of the lenders who provided these loans.”

It adds: “The price of land is also falling back to more reasonable levels, especially outside central London.”

The economy and regulatory environment are the major causes for concern, with the general sentiment being that both will only worsen and that new capital expenditure requirements will make finance more expensive.

Elsewhere the report finds that there is debt available for many developers but, with the exception of residential projects, preletting is a prerequisite.

In terms of other sources of finance the report finds “no evidence that institutions will step in to take the place of the traditional banking sources in the development finance arena” although many banks and developers expect them to do so in the future.

It also argues that it is too early to say whether specialist debt funds will start to fill the gap.

The respondents reported that pricing for finance is increasingly unaffordable with the majority of pricing within the following ranges: upfront fees 100-300 bps; margin 275-450 bps; and exit fees from zero to 250 bps.

Although pricing is increasing, many loans are becoming more recourse, with cost overrun guarantees (and sometimes interest shortfall guarantees) often unlimited.

No speculative development deals have been concluded by the banks interviewed this year. Some sponsors are considering preferred equity in the event that banks are not willing to provide debt finance. Others are considering using cash (assuming this is available internally) to commence building with the expectation that bank finance will become accessible once pre-lets are in place.

The reduction in loan-to-cost ratios (LTCs) to 55-65% means developers also have to find significantly more capital to contribute to the project than they did before the crisis. This has resulted in developments being delayed and/or alternative sources of finance being sought.

Developers with access to alternative sources of finance clearly see themselves as having a competitive advantage compared to smaller colleagues.