Is this the best possible time to invest in property development? Private credit funds and alternative lenders certainly seem to think so. Kathryn Gaw reports…
The property development sector has been through the wringer in recent years. The global financial crisis of 2008-2009 upended the market, then a few years later Brexit came along to disrupt supply chains and slow progress on existing developments. In 2020, construction equipment was left to rust on incomplete building sites for months on end, until lockdown restrictions were eventually eased.
Since then, property developers have been battling with some of the highest interest rates that the market has ever seen, while bank funding has become increasingly hard to come by.
This has left a substantial funding gap in the landscape, which is quickly being filled by private debt funds and alternative lenders who are offering a different type of financing and reshaping the market in the process.
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“With the retrenchment by traditional lenders and tighter restrictions, [property development] lending has become a more attractive proposition to the credit funds,” says Matthew Archer, director at finance broker Tapton Capital.
“Development loans secured by underlying assets have emerged as a more attractive opportunity. This trend, combined with the competitive returns offered by such loans, has made lending a viable and profitable option for private credit funds, and it’s been great working with them on some of our more unique projects.”
Private credit funds have deep pockets, and they are constantly seeking opportunities to invest their capital in suitable projects. According to Preqin data, the proportion of LPs targeting real estate debt – including property development debt – grew from 18 per cent in the first quarter of 2022, to 38 per cent a year later.
Gerard Minjoot, an analyst in research insights at Preqin explained that “real estate debt helps to hedge a portfolio’s downside risk while generating a steady income.”
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Much of the focus on real estate debt funds to date has been around commercial property opportunities. But increasingly, private credit fund managers are turning their attention towards property development. This is due to a number of factors, including the quality of projects, rising investor demand, and the possibility of cheaper financing on the horizon.
“Slowing inflation will help to manage costs and curb the trend of contractor insolvencies that we have seen over the last year,” says Laura Bretherton, finance partner at Macfarlanes.
“Real estate debt funds have seen the opportunity here as banks are even more cautious than previously in funding real estate development.
“Managing development facilities requires more active asset management of the loan from a lender, and certain managers are not set up and do not have the resources to manage the financing of large scale developments.
“Those managers that do are continuing to see an opportunity to provide financing solutions for real estate development where bank finance is not available.”
Property developments are high-yielding investments secured against real assets, which makes them appealing to many institutional and high-net-worth investors. However, development financing has always been considered more risky, and many traditional lenders have shied away from funding these projects, or have limited their exposure in a way which manages their risk. This has only just started to shift in the past year.
“Over the last 12 months, we have seen appetite from debt funds for residential development (both for sale and private rented accommodation), logistics development and life sciences,” notes Bretherton.
These are just a few of the bright spots which have been identified by private credit funds in recent months. The prospect of lower interest rates in the near future has also stirred up excitement among investors.
The average construction project takes 18 months to two years to complete. In two years’ time, the general consensus is that interest rates will have fallen, and bank lending will have ramped up again, making it easier to refinance and exit certain investments. This has led many industry experts to conclude that this is the ideal time to allocate funds to this sector.
“Now is the time for investors to deploy capital,” says Jacky Chan, head of investor relations at Shojin.
“Over the past two to three months things have stabilised. Costs are not rising as quickly and inflation has normalised. For developers this is very helpful because they can accurately price in their bills cost.”
Chan has already seen a rise in the number of transactions taking place.
“People are buying homes again,” he says. “This is the sweet spot right now to deploy capital because property prices have bottomed yet demand is still robust.”
Shojin operates in the mid-market space, funding property projects which are valued at under £60m. This is a key market for property developers, Chan says, as “the big private equity and private credit players are not interested in this segment because the deal sizes are too small so the fees don’t justify it.”
Private credit funds typically back developments worth £100m or more, leaving the small-to-medium-sized projects to alternative lenders such as Shojin, and peer-to-peer property development lenders such as CrowdProperty. As well as working with under-served borrowers, these platforms are unique in that they welcome retail money with minimum investment thresholds as low as £500.
By contrast, private credit funds work at a much larger scale, funded by multi-billion dollar institutions who might allocate £50m or more to a single project. By offering a range of options to a variety of investors, these non-traditional lenders are taking a growing share of the property development market, and they are already leaving their mark.
In the absence of traditional bank funding, these alternative lenders are innovating by offering more flexible solutions for borrowers, and grouping together similar types of deals to add diversity to their portfolios.
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“Developers are bundling different properties or development projects together to create a more diversified and attractive investment opportunity for lenders and investors,” says Archer.
“This approach not only spreads the risk but also enables developers to leverage the combined value of their assets to secure financing on more favourable terms.”
Daniel Austin, chief executive and co-founder at property finance specialists ASK Partners, said that the rise in private credit-funded property development is not only due to bank retrenchment. Austin believes that borrowers truly appreciate the flexibility and holistic solutions that these alternative lenders can offer.
“We are seeing more core plus and value add opportunities which represent a higher return, which aligns with the risk,” says Austin.
“Many of the funds we work with are looking towards distressed debt and assets that can be secured at lower acquisition prices due to commercial landlords struggling with revaluations and margin calls.”
One of the key trends in property development financing this year is the rise of creative capital solutions spurred by increasing land values, development costs and the slower movement of legacy banks who take a very conservative approach to risk. This has made space for alternative finance providers to segment the market in new ways, in response to market demand.
For example, Tapton Capital has seen a number of transactions across Europe within the prime serviced accommodation and the later living spaces.
“Developers are looking into innovative ways to fund their projects, such as joint ventures, mezzanine financing, or crowdfunding,” says Tapton’s Archer.
“Additionally, there is a growing trend of exploring different capital providers beyond traditional banks, including private equity firms, family offices, and even individual investors seeking to diversify their portfolios.”
Archer notes that banks do not generally lend against sites with speculative change of use plans, whereas alternative lenders tend to be much more open minded.
“Alternative lenders have the opportunity to uncover the deals where there is growth potential,” he says.
“But it takes time and specialist knowledge and it doesn’t scale so easily which is why the banks aren’t interested. We have found a sweet spot for loans between the £50-100m mark. Smaller bridge lenders pick up the smaller end of the market and banks take the £100m plus, leaving the mid-range underserved.”
For developers, these alternative lenders can offer a lifeline amid a challenging economic environment. Their cost of capital has increased, valuations have been in flux, and an uncertain macro-economic environment prevails.
If alternative lenders can offer flexible and affordable financing packages to these developers, they could carve out a profitable niche and tap into a lucrative lending market which is crying out for funding.
