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Real estate finance - 2011 and beyond

15 March 2011
These banks who are lending have been doing so through the downturn but in much more challenging conditions and with tighter criteria. It is still a tough market out there, but there is funding available if you know where to look. What has changed, however, are the terms on which the banks now do business. In this bulletin, we address some of the must have criteria that banks look for before lending.


Watertight pre-lets and pre salesThe banks expect to see watertight pre-lets (to tenants with good covenant strength and on the usual lease terms) and pre sales to eliminate risk. Typically, banks will not go below 55 to 60 of development costs. Speculative and part speculative development is still slow, although banks will lend against part speculative development if the right opportunity comes along. There are fewer prime development opportunities coming on to the market for investors right now. This is because the pool of assets which the funds and institutional investors have historically preferred has decreased, hence more and more investors of this type are now competing for the same smaller quality developments with many of the regional players.

Substantial equity participation Banks expect substantial equity participation from borrowers. They also expect borrowers to apply their own equity in advance of any bank funding. As a result of such a large percentage of the equity (perhaps 40 or more) being advanced first, the banks debt is made available for a shorter period of time and, therefore, at a reduced return, hence development finance may not be quite as profitable for the banks as previously. That said, if a borrower wants to refinance (on investment terms) with the same bank following completion, the overall return to the bank is improved and the bank may be willing to lend on more favourable terms.

Raising funding by alternative means In the absence of equity, borrowers should look elsewhere to raise funding: this might be by way of a joint venture (where, for example, building contractors and other developers invest capital in a development project, as well as providing their own development expertise) or where a third party investor enters into a pre-let or pre-sale and also funds a percentage of the development. Cash rich investors may also invest monies to part fund a development alongside banks for an equity return.

Development activity Development activity is stronger in certain areas than others. The London office market is picking up. The premium and special care homes sector continues to thrive and the hotel sector remains buoyant, particularly at the budget and boutique ends of the market. Within the hotel sector, it is interesting to note the banks appetite where the transaction is structured around a hotel franchise or management agreement. Banks prefer solid, water tight pre-lets or pre-sales and many of them will not fund franchise agreements at all.


Market activity There is more market activity in investment finance than development finance just now. This is likely to remain the case for the foreseeable future.

Solid investment opportunities Banks look for solid investment opportunities with good quality tenants occupying quality premises on the usual lease terms. Anything unusual which results in a slightly different funding risk will be less attractive to funders.

Primary and secondary markets Banks are lending to the secondary market due to the relatively high and stable yields (approximately 9-12). The primary market, principally in London and the larger cities, has attracted considerable attention from global institutions, pension funds and wealthy overseas investors who outbid individual and corporate investors. Yields for prime stock are sticking at around 6, which represents a low return for non-institutional borrowers after they have met their funding and associated costs.

Mezzanine funding LTV is around 60 to 65. Banks expect large contributions of equity to be invested upfront. In the absence of equity, borrowers may consider raising any additional finance through mezzanine funding arrangements. Banks are now increasingly offering mezzanine finance products to their borrowers.

Our real estate finance team would be delighted to assist you with any of your funding requirements. We are widely panelled with the regions leading lenders and are at the forefront of market developments. To discuss any of your requirements or to simply find out more, please contact Paul Ray or Nina Armstrong.

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