COMMENT: A fully functioning, purpose-built private rented sector will need debt from the market if it is to thrive.
Reactions to the government’s recent housing white paper have been mixed – almost inevitably, given the scale and complexity of the challenges we face. But one positive is how policymakers have accepted the need for a multi-tenure approach. After several false starts, ministers are unashamedly encouraging institutional investment in the private rented sector and hailing build to rent as a key part of their plan.
Some key issues remain around planning and affordable housing commitments, which may be harder for some developer business models to accommodate than others. These will also directly impact lender valuations and the amount of finance available.
CREFC Europe’s focus is on the availability of credit for this evolving market. Many institutions can invest on an equity-only basis. For others, government initiatives like the build-to-rent fund and the PRS housing guarantee scheme have been critical to building confidence and kick-starting development.
But the UK’s housing sector needs as diverse a range of developers and investors as possible – including, as the white paper notes, SMEs that need debt from other sources or in greater amounts. Much as in the commercial property market, debt is an essential enabler of broad market participation and transactional activity.
Overseas markets such as the US and Germany have shown how the sector can work, from the debt as well as the equity perspective – and those with international experience have been among the early movers in the UK market. One of the biggest debt facilities to date in the sector was pbb Deutsche Pfanbriefbank funding Moda Living’s Angel Gardens scheme at NOMA.
Despite the obviously enormous potential of purpose-built rental housing in the UK, this remains an emerging market, and equity investors have spent a lot more time than lenders thinking about how to make it work. So far, only a relatively small group of lenders, including RBS and HSBC, have established themselves.
To help both lenders and borrowers better navigate financing issues in this market, CREFC Europe is forming a working group comprising bank and non-bank lenders as well as sponsors, lawyers and other advisers. These are some of the issues I expect we will grapple with:
λ Build-to-rent valuation. Existing methodologies based on sales prices do not tally with investment assets. A greater focus on net operating income – such as is seen in student accommodation – would be more suitable, especially for larger schemes, but bridging the divide isn’t entirely straightforward. Another important question is how amenity space should be valued. It may be that lenders need guidance until the market matures and standard approaches emerge.
λ Financing large-scale schemes. Many banks’ lending capacities max out at £50m to £100m, meaning there’s an additional challenge in assembling the scale of financing required for larger schemes. Bringing different lenders together is harder in a new market where underwriting approaches and expectations vary.
λ Build-to-rent underwriting generally. Prelets or off-plan sales are traditional mechanisms to de-risk a scheme and unlock financing. Neither of those options is available for build-to-rent, so lenders need different metrics both to underwrite a development and to monitor progress during construction. Until appropriate market standards emerge, this challenge will be particularly acute for schemes requiring the involvement of several lenders.
λ Transitioning from short-term development finance to longer-term debt for the stabilised asset. There is an infrastructure-like challenge here. Short-term, relatively risky finance is needed for the construction phase, while the finished, income-producing product is perfect for long-term institutional capital (on the debt side as well as the equity). Hybrid debt products are starting to be developed to cover both phases, but we are still in the early stages.
There has been strong interest among our membership in this initiative. A number of UK and overseas banks will be involved, but there is also a lot of interest from a diverse range of non-bank lenders, whether focused on development finance, providing mezzanine debt, or lending against stabilised, income-producing schemes. The equity needs to lead the way, but there are grounds for optimism that the lending market will be there to support this part of the solution to the UK’s housing crisis.
Peter Cosmetatos is chief executive of the Commercial Real Estate Finance Council Europe