New finance sources and the emergence of alternative lenders mean that the Irish real estate finance landscape has changed utterly. Investors and developers in Irish real estate will be particularly interested in our insight into that changed landscape and the options opening up.
The domestic banks have emerged from institutional and economic fragility to bring substantial liquidity to the senior debt market for commercial real estate. In addition, non-domestic banks that had retrenched from non-core markets in recessionary times have shown renewed interest in financing Irish commercial real estate. The domestic and non-domestic traditional banks dominate the senior real estate finance market, where borrowers can expect to be offered a margin of between 3% and 5% above cost of funds, provided that their loan-to-value ratio does not exceed 70% to 75%. The senior lending market has been particularly robust in recent times: the banks have been very active, notwithstanding the more stringent capital controls imposed upon them, and the sectoral and concentration limits within which they operate.
Borrowers that have difficulty meeting the loan-to-value levels imposed by the senior lenders are not blocked from obtaining debt, however, in light of the emergence of non-bank lenders, which have further increased the options available to borrowers, particularly in relation to unitranche loans and mezzanine financing. These relatively new entrants first appeared in the Irish market in response to a funding gap that arose during the recession due to the retrenchment of the traditional banks. Unlike traditional banks, which tap the interbank market for most of their funding, alternative lenders typically raise capital from large insurance funds, pension funds, private wealth funds and sovereign funds. Indeed, some non-bank lenders have accessed funds from ISIF (the State’s Ireland Strategic Investment Fund, a successor to the National Pension Reserve Fund). The presence of these alternative funders gives further depth to the debt market in addition to the traditional financial institutions.
Alternative lenders are primarily involved in providing mezzanine finance and unitranche loans secured against the real estate assets. Mezzanine financing, which all but disappeared from the Irish lending market during the economic downturn, has re-emerged as a real option for borrowers who need to obtain finance in excess of the debt offered by a senior lender. A mezzanine lender will take a “first loss” position and will typically agree that it will not receive repayments of principal for so long as the senior debt remains outstanding. A bank might offer 70% loanto-value with a mezzanine lender topping up with a further 10% of debt to bring total loan-to-value to 80% and bridge the gap to the borrower’s 20% equity. Of course, this type of funding arrangement is more expensive due to the fact that mezzanine lenders take the riskiest slice of the loan: they only get paid after the senior debt holder. So borrowers might expect the margin on mezzanine loans to be in the range of 10% to 13%.
Unitranche is the hallmark product of non-bank lenders and emerged in the US in the mid-2000s. It appeared in Ireland about three years ago as an entirely new product for the mainstream Irish real estate finance market. It combines the senior loan and mezzanine loan into one facility with a single, blended margin reflecting the weighted average pricing of both senior and mezzanine facilities and is a product more commonly made available by non-bank lenders. Loan-to-value ratios of up to 90% will be accepted by a unitranche lender, and although pricing and fees vary considerably from transaction to transaction, margins of between 8% and 12% can be available to borrowers.
The renewed availability of finance is an extremely important part of the return to a properly functioning Irish real estate sector. The good news is that funding for investment in and development of Irish real estate is back, with a difference, and with the promise of increased activity levels in relation to construction and development in particular.