Life after banks: Building without loans

Development finance for UK commercial property has become even harder to come by in the past 12 months, with major lenders now reluctant to fund even fully pre-let projects. Recent research from De Montfort University found that the number of lenders willing to finance fully pre-let developments fell by a staggering 21% in the first half of 2011 to just 31% of those surveyed, while only 15% of lenders are now open to funding speculative developments.

Furthermore, most transactions financed by the banks are to larger organisations such as British Land and Land Securities. They cannot risk lending to those without significant balance sheets - regardless of the merits of the individual project. All in all, the outlook is pretty bleak for those looking to get projects off the ground, and, as the eurozone crisis deepens, there are no signs of a recovery in sentiment among lenders any time soon.

The number of lenders willing to finance fully pre-let developments fell by a staggering 21% in the first half of 2011 to just 31%

But this doesn’t have to mean we don’t build anything. In fact, quite the contrary: when barriers to entry are as high as they are now, great opportunities can present themselves. In the government’s pro-building drive, most of the onus thus far has been placed on the need for private investment when, in reality, private capital is already ready to be deployed. Often, the problem is simply that developers don’t understand the options available, haven’t acquainted themselves with how transactions must be engineered financially, or see private investment as a last resort.

De Montfort’s report should be a wake-up call: banks should no longer be the only port of call for all schemes. Alternative funding models such as stretch mezzanine debt and equity investment could make possible new commercial developments which would otherwise have fallen victim to the fear emanating from the eurozone.
However, this does mean that all parties, the developer included, will be making less per scheme than they were before the credit crisis. While many developers remain attached emotionally to pre-2007 loan-to-values and costs of capital, some have grasped the opportunity before them and are developing many schemes at one time - leaving behind those developers who still hold on to the single project that hasn’t broken ground with the hopes of finding cheap funding.

As well as the obvious benefit of actually being able to finance their scheme, picking the right partner can offer other advantages. The best private investment houses prefer to be far more directly involved in a project than banks typically would be, and see themselves as joint-venture (JV) partners, leveraging their relationships and know-how for the benefit of each project. They can also often bring operators and contractors to the table willing to offer terms and concessions typically unavailable to the one-off project.

So what do developers need to do differently in order to tap into this resource? Think again about running figures based on pre-credit crisis fundamentals and research the current credit climate. Grab a coffee with a trusted broker or project manager and ask them to educate you. What non-central London deals are getting done? Who are the funding partners? How are they exiting the transaction? What does the capital stack of today’s mid-sized project look like?  

For every 10 developers that don’t take the time to understand the current credit climate, there is one that does. They are able to forge a relationship with a partner that can provide expertise, liquidity, manpower and the contacts to make the project profitable. But most importantly, they acquire the ability to do this on a scalable basis. It is no longer about squeezing every bit of profit out of one deal - those days are over. The next five years will most likely be about delivering as many projects as possible with adequate margins, focusing on risk mitigation from the outset. Development has evolved from a leverage game into a volume game, and, in order to win, developers need a funding partner.

Eric Jafari is chief executive of boutique property investment firm BridgePoint Ventures