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Real estate finance - the summer of change?

15 June 2011
In our last real estate update, we looked at emerging trends in development and investment finance. As we head towards the end of the second quarter, we examine new developments in the real estate sector. 

Appetite to lend: what is the forecast for 2011? A recent survey of banks operating in the UK commercial real estate sector reported a marked increase of up to 50 in the amount of debt available for UK commercial real estate finance. Whilst the number of banks in this sector has decreased significantly since 2008, those banks that are still active are looking to increase their lending during 2011. Interestingly, the banks surveyed expressed a greater appetite to lend against new property, rather than refinance existing stock, which may represent an early sign of recovery in the real estate sector. However, whilst the desire to lend is on the increase, many banks are unable to find the right deals, in spite of the increased appetite of borrowers seeking funding. Put simply, the lending criteria have shifted dramatically in recent years: banks are increasingly looking not just to the asset they are funding, but also to the types of borrower that they wish to support. 

 Prime or secondary real estate? Prime real estate is like gold dust, especially in certain parts of Central London where demand remains high and supply woefully low. Prime investments are often fought over by cash buyers, sovereign wealth funds, insurance companies and pension funds, many of whom are able to outbid the banks. Banks have, instead, had to adapt to the market realities and have shifted their attention to "quality" value-added and secondary real estate. As a result of this shift, the secondary real estate sector alone is up 30 on last year. 

 Development Finance - in or out? Early signs suggest that a greater number of banks are prepared to lend development finance in 2011, representing a market shift from 2010. That said, criteria remain every bit as stringent as last year, with banks insisting on watertight pre-lets and pre-sales to good quality third party operators. Speculative development is unlikely to make a reappearance any time soon. 

 What sectors are the banks looking to lend to? There is no change here. Banks are still primarily interested in lending to the relatively stable and traditional sectors of office, retail, industrial and, increasingly, mixed use. Anything niche is unlikely to have the same level of appeal unless the borrower either has an established relationship with the bank in question or is a key player in that particular niche. 

 Why has the cost of lending increased? Regulatory changes and increased funding costs have had a negative impact on the banks ability to lend. This is likely to change the landscape of UK real estate banking for the foreseeable future. This has resulted in banks increasing their focus on reduced loan-to-values and relationship borrowers. Margins have also increased (typically now 2.0 to 2.5) and are unlikely to shrink in the immediate future. 

 Who else is on the horizon? Whilst cash rich equity investors remain attracted to the stable yields and capital investment opportunities that UK real estate offers, the insurance sector may give them a run for their money in the future. Insurers are under increasing pressure to improve returns and the relatively stable yields from UK real estate are an attractive proposition. It is likely that insurers will operate in the high end market and will focus on the large portfolios that banks may be unwilling or unable to finance. However, as banks have the relationships and the teams to provide funding, the future of real estate finance may include banks working alongside insurers and cash rich equity investors. As new means of capital are essential to keep our sector alive, this may lead to new arrangements between banks and alternative debt sources in the future. 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.

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