European banks have been more active in lending to speculative property developments over the past year but this upward spike looks like being short lived according to the third annual European property finance trends report from EC Harris.
The research found that nearly half (45%) of property lenders at European banks are likely to either lend less (22%) or maintain the same level of lending (23%) over the next five years. This was worse than last year when only 3% stated they would lend less, and 29% said they would lend at the same level.
Office (28%) and retail (26%) development projects are lenders’ most preferred asset types. Tier one cities such as London, Frankfurt and Paris are deemed to be most attractive for offices due to their healthier economic growth boosting demand. Tier two cities including Poznan and Wroclaw in Poland and Lyon and Lille in France are attracting increased volumes of lending to retail projects. PPP and student accommodation projects have dropped in popularity as public sector spending falls away. Only 6% of lenders said they preferred PPP projects and just 3% preferred student accommodation down from 15% (PPP) and 11% (student accommodation).
Matthew Cutts, head of lenders’ and investors at EC Harris said: “We are seeing a crisis of confidence amongst the European banks at the moment. Very few are lending speculatively and this is leaving many projects unable to get off the ground. Lenders are waiting until the eurozone situation improves, but with this likely to take some time, lenders and developers need to work together to find new ways of convincing credit committees to accept manageable project risk.”
More than two thirds (63%) of those surveyed also said that they preferred to lend to their home market rather than abroad. Among the reasons given for this were stronger relationships with developers and a greater understanding of that market.
There was also concern that the requirement to hold a greater amount of reserve contained within the Basel III accord is having a detrimental affect on lending. While investors understand the need to remove ‘bad’ assets from their books, this is proving difficult in the tough economic climate, the report said.
Nearly all (97%) of respondents stated that they were more likely to lend to projects that were pre-let, rather than speculative, as these guaranteed a cash flow. Almost half (48%) of lenders had a preference to lend to projects with equity joint venture partners in the form of investment funds as these bring control and governance to a project. Alternative sources of finance such as mezzanine (28%) and corporate or project bonds (22%) were predicted by many lenders, particularly those in Western European banks, as becoming more prevalent in the future.
“Risk can be limited by securing pre-let, but this requires significant investment from the developer,” said Mr Cutts. “The flexibility that joint venture equity projects allow is certainly attractive to banks, however spreading the risk may ultimately result in reduced margins. We are seeing a number of innovative deals in the market at the moment which are helping to secure funding, demonstrating that there are opportunities there for those willing to do things differently.”
EC Harris has identified a number of strategies available to lenders and developers looking to finance projects in Europe, these include:
- use of statistical analysis of successful projects and business plans
- ensuring there is sufficient financing in place through alternative sources of funding such as joint venture equity or mezzanine finance
- lenders should provide earlier feedback to developers on their business plans for project developments
- lenders should accelerate the work out strategy for their distressed assets to allow them to lend elsewhere
- developers can remove as much risk as possible from the project, through securing pre-lets for example
- developers and lenders should build closer and longer term relationships between each other