Lenders forced to look at higher-risk real estate

Copyright: David Lawson - Property Week 

Lenders have swarmed into the secondary sector in a bid to tap the rising tide of returns. At the top end, instruments like mezzanine finance is being packaged with rights issues and equity stakes to lever out big deals for public companies. At the bottom, banks, building societies and insurance companies squeezed out of the prime market are keen to come in a notch lower.

 'Many lenders have been forced to look at higher-risk business as a result of savage pricing competition at the premium end of the market,' says Rupert Clarke, managing director of Jones Lang Wootton Finance.

  Unfortunately, they still manage to give borrowers a hard time, almost as if they still can't quite trust the product which gave them such a bloody nose a few years ago. It is not as though all the property is rubbish. For instance, around half the commercial buildings sold at auction last year were 'fundable', according to Clarke.  In other words, they remain of institutional standard but  were just too small or scattered to be viable for a large group.

 A variety of backing is available. Big operators often use highly sophisticated techniques to grow portfolios. Hemingway, for instance, has a debt profile including £30m of bank loans, £16m of mezzanine stock, a £62.5m debenture and £22.7m of convertible unsecured loan stock.

  This is generally reserved for large scale acquisitions, however, and the mass of the secondary market generally relies on bridging finance and fixed-rate longer-term mortgages. Up to 50 banks are now in the market for property lending, with the Germans and French heavily involved, says  Simon Taylor of Drivers Jonas. terms can vary enormously by region, by branch and most importantly by covenants and lease lengths.

  Cashflow is the common vital factor, and often takes precedence over tenant standing.  But Clarke warns that lenders  are now looking beyond this to take a view on residual value risks.

 At the smaller end of the market, investors and dealers often do not have the quality covenants to offer and work via bridging loans  and convert to long-term finance after a deal is struck. lenders will usually try to spread risk over existing portfolios or seek some recourse to a credible balance sheet or guarantor - although they do not always get it, says Clarke.

  Despite the scramble for business, lending terms can be tough - too tough, says  Jeffrey Selwyn of finance consultants Allsop Selwyn. 'Even the professionals do not seem to realise they could get much better terms if they tries harder,' he says.

  Rates are still being set at 1.25% to 1.5% over basic rates compared with a spread of 0.75% to 1% for prime. 'Lenders could afford much more considering the poor deposit rates they offer savers,' says Selwyn. 'Borrowers should be much more aggressive in their demands.'

 Banks  and building societies provided around half the funding for auction purchases last year, with NatWest taking around 40% of that figure, according to a survey by Jones Lang Wootton. Much of this comes from standing credit arrangements investors take out with lenders based on existing portfolios. This gives buyers speed to act without consulting lenders on each building but does not necessarily lead to the best terms, warns Selwyn. He advises more mixing and matching between deals to get the best rates and loan-to-value ratios.

 Borrowers should recognize their strength  as competition heats up.  Fingers burned by the crash have healed as new management has come through. Like the banks, building societies  see the property market recovering and want a slice of the action. The best way to do this is at arm's length via trusted customers. The Woolwich, Nationwide and Bradford & Bingley are heavily involved in lending, while Northern Rock and Bristol & West have built £1.25bn  of commercial loans.

 Insurance companies are picky about where they will lend but are major players in the market. Norwich Union has  built a £2.5bn book in the sector. Clearing banks shy away from tertiary property but those  like Bank of Scotland and Allied Irish have an appetite for this area. They have been providing 60% loan-to-value terms on a margin of 2% over basic. These elements are tradeable, however with  perhaps an 80% loan ratio available where the buyer takes a narrower margin, says Allsop Selwyn.