By Sam Bolton, Associate Director in Transactions at Alternative Real Estate Advisers (AREA)
A collective sigh of relief could be heard from all those involved in real estate. Interest rates were finally cut from their highest figure in 16 years, with indicators of slowing growth across the pond fanning the flames of expectation for more severe rate cuts over the next six months further.
While the biggest reactions will undoubtedly come from mortgage-stricken consumers up and down the country, the whole real estate landscape and particularly those looking to develop living sectors through development finance or forward fundings, will be encouraged.
Take PBSA as an example. In the last 12 months, less than a handful of funding deals have been struck in this sector. We should know, we put a key one together. The funder? A charitable organisation, hardly a typical counterparty by historical standards. In this market you have to be innovative!
Since Q4 2022, and arguably before, a combination of soaring construction costs and a rebasing of the cost of capital have essentially eliminated the availability of viable fundings across PBSA, BtR, Hospitality and other sectors. The only saving grace in the system has been underlying trade of some sectors, especially hotels, matching or outpacing the high inflationary backdrop. Now as interest rates start to be lowered, some see a light at the end of what has proven a long tunnel, with liquidity starting to flow back to the market. That’s not to say that things will ever be back to the cheap money of the 2010’s. Record low rates seem to be gone for good and inflation lurks in the background ready to disrupt the now anticipated onslaught of rate cuts by the Bank of England.
All the while the reasons for funding new stock have never been more compelling. In PBSA, according to the ICREF, the 20 largest student cities in the UK need roughly 230,000 additional student housing beds in order to address current demand levels, with London alone needing 100,000. In fact, right across Europe, student property is in high demand with PBSA boosted by a post-Covid-19 flight to quality thanks in part to parents becoming much more involved in the selection of appropriately healthy and secure accommodation for their children.
With a strong focus on wellbeing, health & safety and sustainability, fundings are also the only way to secure leading EWS and ESG credentials. This has been well apparent in the funding landscape for hotel assets, with a number of abortive or delayed investments due to compliant yet sub-optimal external wall systems despite a different regulatory regime than the living sectors. Prime fundings are the only route to securing an asset future-proofed against future regulations and ever more stringent in-house ESG requirements.
Extending beyond funding for new-builds, AREA have witnessed an explosion of demand for funded asset remediation programmes across the living sectors, with vendors and tenants all looking to secure compliance without the upfront capital spend and a growing pool of investors (and developers) seeking to crystalise returns from development appraisals that are, frankly, easier to make viable when compared to new-builds.
So if we’re clear on the opportunity and need for fundings, and the underlying investment characteristics being in place, who exactly is going to be stepping up? The widely documented winding up of DB pension schemes, the most active forward funding capital before the market correction, is a good place to start. The £50bn per year risk transfer market in the UK (ABI) will see more and more of the most active capital for institutional-grade funding opportunities flowing from DB schemes to insurers, and they want something different. Developers and tenants need to flex development and lease terms to meet the changing requirements and access the most prolific pool of funding capital if meaningful investment volumes and repeat investment is to occur.
Investors should see an opportunity to delve back into new developments as long as they have the insight and due diligence on their side, covering both the nuances of the property sector(s), and those common and potentially long forgotten pitfalls found in development funding agreements. That’s why it’s worth using an operational expert combined with a savvy transactional adviser – together they see through the weeds that others don’t. And, if they’re worth their fee, they’ll tell you to walk away if the deal isn’t right.
After all, funding – like all real estate practices – is only successful when it’s right. The market from now will remain difficult, and the sweet spot for a viable funding opportunity will be more narrow than before. But regardless, we’re more than ready for its return.
