Massive injections of liquidity have created a large pool of debt capital. Combined with low interest rates, this competition and margin squeeze has created unprecedented lows for the all-in cost of financing for real estate.
At a time of such evolution in the debt landscape, the snapshot that Laxfield Capital provided last week with the launch of its debt barometer, sponsored by the Property Finance Forum, was a crucial insight for all treasurers.
The statistic that highlights the transformation of the market most lucidly is the proportion of financing that relates to acquisitions. This has shot up from 14% in 2012 to now stand at 54%. Emma Huepfl, co-founder of Laxfield Capital and head of its capital management team, provided insight into the shape of the market, describing it as increasingly becoming two-tier – the REIT and long-term fund money is looking for relatively lower loan-to-value ratios with pricing and flexibility as key attributes, while IRR-driven investors are pushing into stretch senior and mezzanine funding to enhance their returns.
With mezzanine pricing now at 6-8% for LTVs of 75-80%, pricing is substantially below REIT’s cost of equity, and becoming almost a must for competing in such a hot investment market.
Other trends we are witnessing include rising LTVs, with more lenders willing to go up to 70% on senior debt; a rise in the number of smaller loans – sized less than £20m – driven in particular by increasing regional transactions; growing demand for alternatives (or the new core), which now make up nearly half of all new loan requests; and increasing duration, with a four-fold rise in requests for durations of more than seven years. With the current all-in cost of ten-year debt for a strong sponsor at around 3%, this trend is set to continue.
Those of us with a memory longer than that of a goldfish know that these sunny uplands won’t last forever, and indeed Huepfl gave some stark warnings. A combination of newer, inexperienced capital in the market and pressure to invest from raised or allocated funds may well lead to bad lending decisions, which will eventually have a knock-on effect across the market. More secondary trades in capital means borrowers don’t always know who holds their debt, never mind actually having a relationship with them. All of that, combined with a world that has an increasing propensity towards global shocks, and the inevitability of another property cycle, means it is crucial that borrowers make the right decisions now.
Alexandra Lanni, head of transactions for Laxfield Capital, came up with some useful pointers in planning and executing a debt strategy. In a world of choice, she urged us to consider factors beyond price in working with a lender. Does it have experience lending to this type of asset? How well do I really know it? What is its credit process, and am I able to meet those involved in the decision? Are they making sensible lending decisions?
Given the potential for volatility around swap rates, she suggested considering locking in rates earlier in the process, so that there are no last-minute nasty surprises. And ensure you understand the credit spread you will be charged ahead of time and understand the trade-off between pricing, LTVs and flexibility. Maybe I have too many scars but on a personal note I would opt for maximising flexibility every time.
She also stressed the importance of actively managing compliance, creating a schedule of reporting requirements and dates and agreeing them with the lender.
Overall, the message was manage your debt relationships as pro-actively as you would your equity relationships. Be aware though, that this is no substitute for getting the documentation right. We were left with a very contemporary warning – you could think you are borrowing from GE just to find your lender is actually Blackstone.
Rebecca Worthington is chief executive at Lodestone Capital
