Real estate development is a complicated business even in good times. Anyone who’s been on the development journey knows this, and probably has the scars to prove it.
Over the past few years, traditional lenders who have built relationships with local developers, retreated from the market and that gave an opportunity for alternative lenders to fill the gap. The main problem was these lenders were more driven by getting capital out the door and generating fees, than they were about the underlying loans they were underwriting. Development lending went up and it was happy days for everyone.
Today as GDVs shift lower and as sales periods have extended by 16% in the last 24 months, a lot of these funders (and borrowers) are feeling the pain, and many loan books are severely in default. The automated tick-box lending approach is a dangerous way to lend to something as complicated as real estate development where a variety of things can hiccup even in the best of times.
A New Wave of Change in Alternative Lending
But the landscape is changing. A new breed of lenders in emerging in the space just in the nick of time. With the recent announcement of KKR recently teaming up with an alternative SME development lender, the alternative lending market is rapidly moving it up a notch. It appears that the early pioneers of P2P proved that the concept of alternative lending worked, followed by the household name alternative lenders, and now that the model is proven, a more real estate savy institutional type of alternative lender is slowly appearing to help solve the problem.
And why not. The SME lending market is vast. The UK, by all accounts, needs roughly 300,000 new homes per year, and the financial requirement to make that happen is a whopping number over the next ten years. Add on top of that the overall social focus of bringing back smaller SME borrowers back into the mainstream by government supported programs and you have a cocktail for opportunity and growth in this market. It is no wonder so many institutional investors are paying attention.
Nationwide Building Society indicate that the funding gap for the next 10 years, based on the annual target for new homes, is circa £208 billion
But…..many of these institutional and new challanger providers of residential development finance may not have the skill-set to underwrite smaller developments loans which take time and oftentimes are done on a bespoke basis. Deals between ~ £3mm up to £15mm are falling through the cracks. Where “one shoe doesn’t fit all”, big institutional type lenders are by their very nature “Big” and are required to rely on automation and volume. This opens the way for smaller boutique lenders to enter the market, backed by more risk-savy capital. These entrants, small and with skills and capital, will move faster and increase competition in sourcing and funding residential development projects.
It’s Not Tick Box Lending
In fact, many of these new smaller competitors to the market will probably have greater real estate development, financial, technical and market research background which will up the ante considerably. Additionally, some of these new entrants may have higher risk tolerances, different risk assessments or even access to different sources of funding, which will allow them to take on a wider variety of loans and establish more relationships than the larger newcomers.
With a focus on SME lending, filtering better known developers is a “meet and greet” type of business, a lot of tire kicking, with a track record even more important than the project itself. Only getting out there and kicking the tires will do the trick; understanding the highest degree of comparability on sales, costs and investment characteristics can determine the quality of the project and this is where smaller real estate savvy firms will have an advantage.