Tuesday, May 11, 2010

Reluctant lenders might cost builders in future

Developers aiming to time projects from '11-'14 as rents promise to be high

(LONDON) Jittery lenders and hefty margins on central London prime office construction finance may stunt speculative building until 2014 and stop developers from timing projects to coincide with an anticipated sweet spot in rents.

'It's the easiest thing in the world for a bank to just say no to development loan requests . . . Most banks used to lend like every deal was a safe bet. Now many of them won't lend a penny to developers,' said Solly Benaim, head of real estate at BDO.

The global financial recession saw many London developers postpone or cancel prime office projects as unemployment rose, while rents and construction costs fell. Now, they want to kickstart projects, but lenders remain wary of the risks.

Savills' commercial research head, Mat Oakley, is advising clients that 2011-2014 promises to be a boon for landlords keen to let prime offices to space-hungry companies that are growing on the back of economic recovery.

'Lenders' caution and the almost non-existent development pipeline almost everywhere in the UK is not an ideal situation for UK public limited companies because the economy will recover and businesses will grow,' Mr Oakley told Reuters.

Lender wariness is seen in the high margins for construction finance. Analysts said loan-to-values of 50 per cent would likely have margins of about 175-375 basis points (bps) over Libor, those on 65 per cent LTV reaching 200 bps-plus.

'It takes hundreds and hundreds of millions of pounds to build some of these schemes but I can't think of any banks willing to contemplate development loans in excess of £75 million (S$155.2 million),' one senior UK banker said.

Capital adequacy rules for banks, in accordance with Basel II controls, are designed to discourage risky development lending, and have made it near impossible for banks to give finance on large-scale construction projects without a significant number of pre-lets.

'Some people have accused us of withholding funds from the market. The fact is we couldn't lend (to speculative projects) even if we wanted to,' the senior UK banker said.

Nick Berry, a partner at property fund manager Mountgrange Investment Management, said: 'They are picky about the sector, the sponsor, pre-lets and the covenant. A developer really needs to tick all those boxes before they can be confident about securing the debt they need.'

Chris Vydra, a partner at property advisor Knight Frank, said that new office supply in the City would remain at historically low levels for at least another two years. Analysts are forecasting the delivery of about 1-2 million sq ft of prime office space a year in the period 2011-2014, against average annual demand of about 4.5 million sq ft, effectively serving to lift rents and suppress vacancy levels.

Mr Vydra expects normal rents to hit at least £52.5 pounds a sq ft by end-2010, up 19 per cent from about £44 in December. 'At the end of last year, some people thought that (forecast) was totally unrealistic, but we might even be a little light on that estimate,' he said.

Some developers are already hawking their plans around banks with a view to getting finance for construction or refurbishment work, and Savills' research shows some are tentatively in the market to provide this, at a price.

It lists Barclays, Close Brothers, HSBC, Eurohypo, Lloyds Banking Group and Royal Bank of Scotland as potential sources of finance. Developers wanting to time their re-entry into an improving market are also mulling other options, including joint ventures, syndicated loans, fund raisings, and forward-funding agreements.

'To get your partner signed up, you're going to have to have a very convincing story and as much certainty on price and construction costs as you can,' said BNP Paribas' Dan Bayley.

If successful, these developers may cause a wave of project completions at the end of the 2011-2014 sweet spot. - Reuters

Source: Business Times, 11 May 2010

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