The Changing Landscape of Real Estate Funding

The global financial crisis has had an impact on almost every walk of life and has changed the way in which businesses can source funding for their ventures and expansion...

The global financial crisis has had an impact on almost every walk of life and has changed the way in which businesses can source funding for their ventures and expansion. This is certainly no different in the property investment and development world, with a rising number of construction firms having to seek alternatives to traditional bank loans.

This is because, as head of UK and Europe, the Middle East and Africa (EMEA) debt advisory at CBRE Natale Giostra explains, big banks are reluctant to lend at high loan-to-value (LTV) ratios. "If you look at the UK's leading banks or commercial banks, probably the maximum LTV that they will even feel comfortable offering to clients at this point in time would be 60 per cent LTV," he asserted.

William Newsom, valuation director at Savills, paints an even bleaker picture of the state of commercial property development finance in the UK. He says that developers cannot obtain finance for projects unless they have "secured a pre-let, either of the whole or a substantial part of the building". However, he points out that there is more finance available for residential real estate schemes.

So, with the big financial players unwilling to lend to developers, where can they turn for funding? The answer is to mezzanine finance and bridging loans, both of which are becoming increasingly popular. In fact, DTZ predicted in April this year that mezzanine finance, coupled with debt from institutions, would "compensate for this reduction [in lending from commercial banks]". A bridging loan is a way of obtaining money quickly on a short-term basis, and, as such, the interest rates associated with repayments can be high. Mezzanine finance also comes with high rates attached to it, primarily because the lender will provide the funds without conducting a great deal of due diligence, thereby enabling the cash to be accessed quickly by the borrower.

Despite the high interest charged on mezzanine and bridging funding, Mr Newsom believes they are a vital feature of the UK's construction sector. He describes them as "a necessary part of the capital stack", and goes on to explain that some developers will choose to take out mezzanine finance, even when they have funds available because they need to "preserve working capital for the business". "Working capital is necessary for bringing forward the next project, for contingencies in the current project, and generally for ensuring the continuing solvency of developers," he elaborates.

In a recent interview with Bridging and Commercial, partner at mezzanine lender Ultimate Capital Nils Baker said another reason why developers turn to this form of financing is to maintain control and, ultimately, help them realise a profit on their projects. He explained the main options for developers once banks have closed their doors to them is a mezzanine loan or to find an equity partner, but the latter will usually result in a loss of control and the potential for having to share a large portion of the profit with another firm.

Mr Baker went on to point out that, even with the high rates of interest charged on mezzanine finance, a developer still stands to receive the majority of the profit once these costs have been accounted for, which is preferable in the long term to signing up to a partnership that could cost more when the project in question reaches its conclusion.

There is no shortage of providers of this kind of financing either, with Mr Newsom stating there are many organisations offering this type of loan "right across the range". It is not only the mezzanine sector that is growing, as new research published this month by West One Loans indicates the bridging loan market is set to expand in 2013. In the firm's Bridging Index, 71 per cent of the brokers surveyed believe their bridging activity will increase over the coming 12 months, while commercial bridging loans were reported as a growth area for 93 per cent of the professionals questioned.

- Monday 01 October 2012

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