In the course of working in the property finance sector for more than 25 years, I have seen the attitude of lenders to property investors change substantially, writes Stuart Buchanan.
Until the financial crash, if a bank liked a client, it would work hard to structure finance for whatever type of property transaction the client was trying to achieve. To use a medical analogy, banks were general practitioners.
After the crash, this approach all but vanished: lenders now tend to be specialists and the days of the one-stop funding shop have gone.
It means that the real estate lending picture is now extremely fragmented, with lenders looking to specialise by lending on specific sectors, rather than across the whole market. Borrowers can spend a lot of time barking up the wrong tree if they aren’t aware of each lender’s specialism.
However, the positive flip-side to this is that lenders are now taking a varied approach and will look at situations that the “vanilla financing” of the past would not have encompassed. A good example of this is commercial investment properties with fewer than five years to a tenant’s break option or lease expiry. The sweet spot for lenders was income secured on long leases, with five years often being the minimum term they would consider.
| Differing attitudes to debt service coverage | ||||
|---|---|---|---|---|
| Tenant Covenant | Margin | Debt service based on £100k rent | Interest only | |
| Lloyds | Weak – Strong | 2.6 – 4% | £700k – £900k | No |
| Santander | Medium – Strong | 2.5 – 3% | £850k | Yes |
| Barclays | Medium+ – Strong | 2.75 – 3.5% | £750k | Yes |
| Metro | Weak – Strong | 3 – 4% | £900k | Yes |
However, the length of commercial leases that are granted across all sectors – perhaps with the exception of leisure assets – is now reducing. So if lenders are going to “get into the game”, in many situations they are going to have to be more receptive to assets secured on short-term leases.
During the past year, a number of lenders have started to lend on both single-tenant short leases as well as multi-let short leases. Loans against shorter leases are normally structured to amortise to a percentage of the vacant possession value of the property. This percentage varies between lenders.
Borrowers should also be aware that in today’s lending environment what constrains finance for investment properties is not normally the loan-to-value covenant. It is the debt service covenant – which can vary enormously – that caps the majority of loans. Debt service covenant ratio is the ratio of cash available for debt servicing to interest and principal payments. It is a popular benchmark used in the measurement of a potential borrower’s ability to produce enough cash to cover its debt payments. The lower this ratio is, the easier it is to obtain a loan. Breaching a debt service covenant can, in some cases, be an act of default.
A recent example of debt service coverage at work concerned a client I was advising on the refinancing of a portfolio of commercial investment properties in London. Lender A offered terms with a maximum loan of £5.5m, while – for the same properties and rental income – lender B offered terms for a £9.8m loan. It’s hard to believe that one loan could be 78% more than the other on the same portfolio, but it shows how policy on debt service covenants influences lending.
This outline summary of several clearing banks and a challenger bank based on my experience of new-to-bank clients illustrates some of the differences in lending policy (see below).Sometimes it is not only between lenders that loan terms can vary. It can also happen between geographical areas covered by the same lender organisation. Lending appetite can change depending on the local office culture, how much business comes through its doors and even how close to the end of their financial year it is – one manager has comfortably hit their target, while another still needs to draw down loans to meet their objective.
| Differing Attitudes to Development Finance | |||
|---|---|---|---|
| Max loan to GDV | Max loan to cost | Interest Rate | |
| RBS | 55% | 60-65% | 3.5-4.25% |
| Paragon | 65% | 80% | 6-7% |
| Octopus | 70% | 80-90% | 10% |
The development finance sector is possibly even more fragmented. There are around 50 lenders offering various types of development finance. Each lender has a set lending policy which has a loan capped at a percentage of loan-to-cost and a further cap, which is capped at a percentage of gross development value. The loan-to-cost ratios vary between 50% and 90% and interest rates are linked to the level of equity the developer is putting into the deal, with rates varying from 3.25% to 12%.
Lenders can be very subjective regarding the actual developments themselves, with identical risk lenders sometimes lending or not lending based upon their personal opinions of locations, property type or even the design of what is being built (see table above).
With so many different options and constraints on finance, it can be difficult to find exactly what a borrower requires without specialist advice to make the funding picture clear. This is particularly true for the private investors who are increasingly entering the commercial property sector for the first time and realising that having the right structured finance is key to building successful portfolio holdings.
Stuart Buchanan is a director of specialist property lending adviser Acuitus Finance
This article appears in the latest edition of EG’s Property Auction buyer’s guide, available in newsagents from 20 May. For full and free digital access to the guide, please click here
