The Vote to Leave has brought difficulty, uncertainty and volatility to the financial markets. We are currently in a ‘wait and see’ post-Brexit world. It will be many months before clarity emerges regarding the UK’s new political, economic and strategic role on the global stage.
However, John D Rockefeller once famously advised on turning disasters into opportunities. Even in the current circumstances, there are still commercial opportunities waiting to be discovered; deals to be done; and profits to be made in the real estate sector.
The real estate lending market, once dominated by the big banks, now includes a greater diversity of lenders. Non-bank players (insurers; pension funds; private equity and private wealth funds) have become increasingly active in the lending vacuum created by the 2008 Lehmans collapse and attendant financial crisis.
Insurers have demonstrated their appetite for real estate lending. BlackRock’s 2015 Global Insurance Research report indicates that 82% of insurers surveyed are intending to increase their exposure to alternative assets such as real estate. Long term lending suits the long term liability profile of the insurers and with attractive pricing, this has provided stakes in some very large transactions and portfolios.
Between Jan 2008 to mid 2013, the top 50 private equity houses raised nearly USD 200 billion to invest in real estate through debt and equity. The contribution of private debt funds to UK commercial property lending is still small in comparison to that of banks, at 26% of the European-focused lending market (in 2013); but it is growing. The more speculative end of development finance is often a popular investment sector for private equity, in contrast to the pre-let or pre-sold schemes preferred by banks. Many of the funds have been raising and continue to raise new money. Cerberus has been fundraising for its latest USD 2 billion real estate fund. Market-leading distressed debt players Oakhill and Apollo have also been fundraising and will be seeking investment opportunities shortly. The product range of these funds is wide and flexible.
The peer-to-peer lending market, in its infancy, but growing rapidly, has shown a marked appetite for real estate investment. In 2014 to 2015, debt and equity funding in the real estate sector from this set of alternative lenders reached £700 million. 41% of the total volume of peer-to-peer business loans in 2015 was attributable to real estate loans. The sums at stake per transaction are currently small, but loan sizes are growing. It is worthwhile noting that the online alternative finance sector grew by 84% in 2015. Loans to small/medium-sized property developers dominate this sector.
‘Shadow banking’ is generally understood to mean ‘non-bank credit activity’. Key shadow banking activities include: deposit-like funding structures; leveraged positions; the avoidance of regulatory supervision; the interweaving of many contractual relationships with banks. Hedge funds, investment funds, asset managers, insurers, pension funds and peer to peer lenders have all been variously badged as shadow bankers, although this is an unwelcome description from their perspective and somewhat misleading.
Calls for reform came soon after Lehmans collapsed, when regulators were criticised for allowing leverage levels and attendant risks to rise unnoticed outside of the banking sector. The banks themselves, hit by the cost of implementing the stringent regulatory requirements of Basel III, lobbied for similar regulation to be imposed on non-bank lenders, to create a more level playing field. Broadly speaking, AIFMD; Solvency 2; and MIFID 2 form part of a patchwork of European legislation introduced during the financial crisis. AIFMD and Solvency 2 have been implemented in the UK. MIFID 2 is to come into force on 3 January 2018 and the FCA have clearly stated that firms ‘must continue with implementation plans for legislation that is still to come into effect’.
Although all three regimes require alternative lenders to hold regulatory capital, whether the big banks think this is sufficient is a moot point. Additionally, post-Brexit, it is difficult to imagine that UK regulators will have the appetite or resource to pursue further reforms in the near or even medium term future. This shift in policy will favour alternative lenders.
- UK and overseas pension funds have warmed very quickly to the notion of investment in the private rented sector and in particular, UK PRS. In the London market, this is being supported by Sadiq Khan, and on publicly-owned land, the GLA has imposed a further obligation – JV arrangements are only open to developers who will provide approximately a third of the units as PRS on site;
- Purpose-built student accommodation is becoming more interesting – there is a suggestion of a shift towards accommodation which would be PRS and open to both students and non-students. This is to stifle the increasing student accommodation/‘ghetto’ planning arguments, and to encourage balanced and mixed communities. PRS is a residential use and broader than student accommodation. PRS (subject to price) gives access to both markets. It is also the case that student accommodation is coming under increasing pressure at the planning permission stage. Local authorities want a form of mainstream but ‘student-affordable’ accommodation within each development;
- New shed sites and shed opportunities, particularly with rail links, are in demand. There is a fresh focus on some of the ports along the south and east coast, like Harwich and Southampton, where expansion plans will need to be aligned with warehouse and distribution networks;
- A revised form of retirement living is coming to the fore. Whilst the McCarthy & Stone model has returned to the market and is successful again, having been overstretched in the pre-recession and recession years, these developments are aimed at people looking to downsize portfolios of property with more flexible living arrangements. This too is part of wider government policy to free up homes which have become too big for their owners;
- We can expect the emphasis of the Neighbourhood Planning & Infrastructure Bill to shift to development and infrastructure, with less focus on neighbourhood planning changes, as part of the move to attract overseas investment. The Bill was likely to have been devised assuming a Remain vote. The government that will now exist is in a different economic environment; they will want easy and early wins;
- Post-Brexit, the Secretary of State for Transport has indicated that spending on transport will rise by 50% in this Parliament. On infrastructure generally, there have been many and various influential voices calling for increased government spending: “The combination of a new Chancellor, low interest rates and Brexit means that now is the time for decisions to be taken and investment to be made…If the government leads the way, private investment will follow.” (Vernon Soare, COO, ICAEW). Likewise, Sadie Morgan, who sits on the government’s National Infrastructure Commission, has commented post-Brexit that “long term projects that offer certainty of investment, growth and jobs are just what this country needs”.
A final word…
It is clear that in the real estate lending space, banks maintain and are likely to maintain a dominant position; but it is also clear that alternative lenders are here to stay. There are many opportunities suitable to the regulation-lite alternative lender community, building on the platform that they have established since the post-Lehmans crisis.
More generally, there is much truth in the saying that bad times make for good bargains.