SHORT TERM REAL ESTATE FINANCE
Current market conditions mean that traditional bank debt for real estate transactions is severely restricted, with many banks still facing liquidity issues ten years after the financial crisis of 2008. A number of quoted companies are now issuing Retail Bonds to bridge the gap, however, this solution is not readily available to SME property developers.
At the same time as the banks have cut back their lending activities, rates offered to depositors have been reduced, reflecting the exceptionally low interest rate environment that has existed for the last decade. This has led a proportion of the investing public to look at alternative yield-producing investments and has created an opportunity for companies that are able to match surplus investor liquidity with cash-starved real estate companies.
These Peer-To-Peer Lenders now provide important levels of liquidity to smaller property developers, as well as much needed income to investors.
Why Asset-Backed Lending?
Property funds and debt funds are established investment vehicles of which most investors will have some experience. However, very little (if any) control can be exercised over which assets are purchased / funded, where they are located and what the exit strategy is. By contrast, a Peer-To-Peer Loan is made against one specific asset, for a clearly-defined purpose and timescale and with total control over the security for the loan. Returns can also be targeted, simply by increasing or decreasing the level of risk adopted – e.g. by varying the Loan To Value (LTV).
In an environment where yield can be very hard to come by and where political uncertainty hangs over financial markets, loans secured against UK property can provide excellent risk-adjusted returns. Peer-To-Peer loans can carry LTVs of as little as 50%-65%, providing a useful buffer against market fluctuations.
By carefully selecting viable projects, undertaken by experienced developers with a proven track-record, lenders can achieve healthy returns, safe in the knowledge that their cash is secured against a real asset. Personal guarantees then ensure that the developer remains fully focused on making the project a success.
Investors can choose to fund one specific project, or create a portfolio of loans with varying returns and maturities, to match their own risk-profile and yield requirements. Whilst no-one would suggest putting all of your eggs into the Peer-To-Peer Lending basket, asset-backed loans could form an interesting and important part of your portfolio.
Bridging Loan are typically arranged for 6-12 months and are most frequently used to fund a property purchase pending a planning application. The loan will be drawn in one amount and the LTV should be based on the value of the property without planning permission. In most cases, planning consultants will already have begun a dialogue with the local authority, meaning that a successful outcome is reasonably likely. The exit will be achieved via a sale of the property with enhanced planning permission, or a refinance via a development loan.
Nevertheless, it is important in such a situation to understand what the exit route is if the application is unsuccessful and the developer should be able to demonstrate that such a plan exists.
Development loans are provided where planning permission already exists and are normally utilised to fund both the initial purchase (or bridging loan refinance) plus development costs. It is crucial to ensure that the funding of development costs is permitted only once each stage of development works has been checked against the initial appraisal and budget. An independent quantity surveyor should be employed on behalf of the lender, to undertake regular visits and to check invoices, as well as the progress and quality of works.
Most development loans will run for 12-24 months. During this period it is important to keep a close eye on the exit route – for example, with a residential development, efforts should be made to sell a proportion of the units off-plan. Or, where the developer intends to retain and refinance the property, a close eye should be kept on lettings and on negotiations with the lender that will provide the refinance.
The G9 has created an investment vehicle to enable Families to invest in this sector with three distinct mandates:
Advisory – asset by asset
Discretionary – multiple direct assets
Discretionary – fund approach
After undertaking considerable work in this sector, the G9 selected Invescap to manage the lending portfolio:
Invescap was established in the Channel Islands in 2011 and began trading in 2012, since when it has funded around 70 transactions, with loan sizes varying between £100k and £5m. Loan terms are usually between 6 and 24 months and are secured by a legal charge over the property being financed and, in most cases, personal guarantees from the directors / shareholders of the developer.
Between them, the management team at Invescap has over 80 years experience in banking, accounting, trust and property finance. The principal, Steve Herbert, has held senior positions with a number of international banks in Credit, Structured & Syndicated Finance, Property Finance and Private Banking. His colleague, Ian Parkin, has held senior positions at accounting firms and trust companies and, for the last 20 years, has run his own property management consultancy business.
Invescap works with a small number of hand-picked real estate developers, providing senior and sometimes mezzanine debt. Investor money is deployed under Invescap’s careful control and is drawn only after Invescap’s in-depth review of the proposed project. Returns to investors are commensurate with the risk being taken and typically range between 7% - 12% p/a. Transactions to date have ranged from simple flat conversions, to new-build residential, mixed use developments, student accommodation and nursing / care homes.
The key to successful Peer-To-Peer lending is in selecting the right developers and the right projects. They undertake detailed due diligence on each developer before commencing a relationship and a thorough appraisal of each project before committing funds. Development loans are drawn in tranches and each loan drawdown is released only after an independent Quantity Surveyor has visited the site and valued the works undertaken since their last visit. This ensures that budgets are adhered to and that works progress in line with approved Planning Consents and Building Regulations.
The team oversees the entire process, from carrying out due diligence on the developer, assessing the project, visiting the site, instructing the solicitor, valuer and (for development loans) an independent Quantity Surveyor. They then handle the loan drawdown(s), interim reporting, interest calculation, loan administration and finally repayment. This is all designed to ensure a smooth and stress-free experience for the lender.
What if things go wrong?
Planning decisions sometimes get delayed or appealed. Property development can be delayed by inclement weather. By selecting the right developers and the right projects, Invescap aims to keep these situations to a minimum, but it would be naïve to think that such problems will never occur.
When a company in which you own shares issues a profit warning, the major institutional shareholders will control any vote on replacing the board, etc. When a bond you hold defaults, the covenants dictate what happens next.
By contrast, if a Peer-To-Peer loan you have made is in default, you have total control over whether to renegotiate terms, grant an extension, or simply enforce your security. Invescap can advise you in this situation and will manage your security and exit route in accordance with your directions.
Such problems are rare, but you can be sure that whatever happens, Invescap’s team will have seen and dealt with something similar previously. And with a loan at a modest LTV and with guarantees in place from the directors / shareholders, you can be sure that you, Invescap and the developer will all be very keen to ensure a satisfactory outcome.