Residential property is not the only thing in short supply in Prime Central London - the funding needed to develop new stock is equally hard to secure.
Not so long ago the high street banks were falling over each other to finance residential projects. Now they are being extremely selective. If a developer is fortunate enough to fall within a bank's core criteria then access to relatively inexpensive debt is available, albeit at a loan-to-cost that may require topping up with mezzanine finance. Outside those criteria, a plethora of specialist lenders, family offices and ultra high net worth individuals (UHNWs) are filling the void.
Family offices and UHNWs sit at the heart of this trend for two reasons: their confidence in the Prime Central London residential market and the opportunity to earn good returns on cash over 12-18 month periods.
Their confidence in the market comes from the depth and breadth of demand for property, both domestic and overseas. For overseas property investors in particular, London is seen as a safe haven for capital because:
- Britain has a long and uninterrupted history of political stability, recognition of property rights and maintenance of the rule of law, giving purchasers confidence that assets purchased in London will not be confiscated.
- Taxes on capital are relatively low and acquisitions can be structured efficiently, so Britain remains an attractive investment location for people domiciled abroad.
- London has become a centre of excellence for UHNWs. From restaurants and galleries, through schools and universities, to wealth management and professional services, London has a critical mass that few rivals can match.
Private money enters the market through various conduits, ranging from purpose-built debt platforms such as Contour Capital and Capital A, through financial advisers and multi-family offices, to developers-turned-lenders such as Urban Exposure. It is a fragmented market and, like the property market as a whole, can be reached through brokers, personal contacts or a mixture of the two.
Whilst precise reasons for choosing to enter the lending market vary, the common theme is that residential development funding earns good rates of return on a risk-weighted basis. The source of repayment is clear: the cashflows generated on sale of the completed units, typically after 12-18 months, which in most cases are underpinned by strong demand. With deposit rates at historic lows, allocating a portion of cash holdings to development lending makes sound financial sense. Whilst there is significant risk in any development project, notably cost overruns, these will typically be underwritten by the developer, leaving market liquidity as the funder's principal concern.
It follows from this focus on liquidity that many lenders will only lend once planning permission has been obtained. They are also wary of backing projects where the market for the product may be thin or particularly dependent on niche purchasers, for example properties costing over £20million. There are some locations where the level of development is so high that demand may be stretched. This is a particular concern in areas outside the traditional core.
Specialist lenders tend to be more expensive than mainstream ones but also more flexible. So, if you have an issue with a property that would make it unbankable according to a high street lender's strict criteria, a private lender may well be more accommodating. And whereas high street banks tend to be slow in reaching a decision, private money is generally able to commit quickly and take views as the transaction progresses.
This article by James Dakin originally appeared in Prime Resi in May 2014.