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Demand for UK property fell by 16 per cent in February

The number of house hunters registered at estate agents slumped 16 per cent last month, according to a new report by NAEA Propertymark.

The number fell from 367 registered per branch in January to 309 in February, with a 28 per cent year-on-year drop. Agents had 425 house hunters registered per branch in the same month last year.

In line with demand, the number of properties available for sale per branch dipped from 36 in January to 35 in February. The rate of properties which sold at asking price was at the highest level since June 2016.

Sales to first-time buyers rose last month though, reaching their highest point since February 2015.

The February housing report said the chancellor’s first-time buyer stamp duty relief seemed to be having an impact, with sales to the group rising to 29 per cent last month – up from 27 per cent in January.

Last year, first-time buyer sales stood at 22 per cent, and in 2016 they were at 24 per cent. The average number of sales agreed per branch increased from seven in January to eight in February, which was the highest reported since last October.

Mark Hayward, chief executive, NAEA Propertymark said: “Since the chancellor cut stamp duty for first-time buyers, there have been a good level of sales to the group, but they haven’t rocketed.”

He said Propertymark members had noticed first-time buyers holding off on making purchases since the rule was introduced – typically outside of London – instead deciding to save for longer to maximise “the full stamp duty relief”.

Hayward added:

This may be one reason why sales are up but not as high as we might expect; the other reason is that the cost of buying is still very high, and first-time buyers are still finding it difficult to save for their deposit.

As the cost of living continues to rise – with consumer price inflation standing at 2.5 per cent in February – we still have a long way to go to make the dream of owning a home accessible to all, but this is definitely a step in the right direction.

Source: City A.M.

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London’s house price growth hits seven year low

House price growth in London hit a seven year low with two fifths (42%) of postcodes across London registering year-on-year price falls, the latest Hometrack UK Cities House Price Index found.

The headline rate of house price growth across the capital has slowed to 1%, down from 4.3% a year ago. This is the lowest annual rate of growth since August 2011.

In contrast, regional cities such as Edinburgh, Liverpool and Manchester are registering house price growth in excess of 7% per annum.

Richard Donnell, insight director at Hometrack, said: “The weakness in London’s housing market has been building since 2015 on the back of numerous tax changes aimed at overseas and UK investors and growing affordability pressures facing homeowners.

“Sales volumes are first to be hit when demand weakens and housing turnover across London is down 17% since 2014. Sales prices are next to follow but with few forced sellers the level of price falls remains low.”

The slowdown in the capital is driven by single digit price falls across inner London – 15 of the 46 local authorities that make up the London index are experiencing price falls.

The ones that have seen the greatest downward pressure on prices over the last year are the City of London (7.9%), Camden (1.9%), Southwark (1.8%), Islington (1.4%) and Wandsworth (1.2%).

House prices continue to increase across the majority (58%) of London postcodes but the number registering positive growth has declined over the last 12 months.

Based on current trends, Hometrack expects year-on-year house price growth to shift into negative territory by the middle of 2018.

The Hometrack index reveals that house price growth outside southern England remains robust, well ahead of the growth in earnings. Overall UK city house price inflation is up 5.2% year-on-year as the rate of growth between southern cities and regional cities continues to diverge.

Donnell added: “We expect the balance of markets registering price falls to increase over 2018 as prices continue to adjust to what buyers are prepared to pay. Average London house prices are up 86% on 2009 levels so there is a sizable equity buffer to absorb any price falls.

“Away from southern England house price growth remains robust in regional cities where prices have registered lower overall growth since 2009 and affordability levels are in line with their long run average.”

Half of cities covered by the index are recording higher price growth than a year ago while the other ten are registering lower growth led by Bristol, Southampton and London.

Prices are falling in Cambridge (-1.5) and Aberdeen (-7.7%) – Cambridge is performing like an extension of the London housing market.

There are five cities registering house price growth in excess of 7% – Edinburgh, Liverpool, Leicester, Birmingham and Manchester.

In London, the coverage of markets registering negative house price growth (currently 42%) is at its highest since the global financial crisis.

This is a result of numerous tax changes impacting overseas and domestic investors and stretched affordability levels for owner occupiers that have been compounded by Brexit uncertainty.

The majority of these markets are falling by between 0% and -5% with no signs of any acceleration in the rate of price falls.

The downward pressure on house prices is greatest across inner London areas where prices are highest prices and yields lowest, and where there is a greater share of discretionary buyers.

The time it takes to sell a residential property in inner London has risen to 18 weeks, almost double that of outer London and the city’s commuter areas.

Source: Mortgage Introducer

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2 reasons why the market is fundamentally misjudging the Bank of England’s next step

  • The Bank of England hinted that it is set to hike interest rates in May, but there are signs it could change its mind.
  • A rate hike in May is, in the words of bond market guru Mohamed El-Erian “far from a done deal.”
  • The wording of the committee’s statement is far less explicit than that in the Bank of England’s statement in September last year, the meeting prior to its November rate hike.
  • This suggests some reticence to hike on the bank’s part.
  • The make up of the vote of bank’s Monetary Policy Committee also raises concerns.

LONDON — As expected, the Bank of England left interest rates on hold on Thursday, but signalled — in the eyes of most commentators and many in the markets — that a rate hike at the next meeting of its MPC is all but guaranteed.

After hiking rates for the first time since the financial crisis last November, the bank spent much of the rest of the year signalling that it will likely raise rates further in 2018.

Most had expected hikes towards the end of the year, but an unusually upbeat MPC statement in February brought that horizon forward to May.

March’s statement seems to confirm that, with two MPC members voting for an immediate hike, and the bank as a whole saying that “an ongoing tightening of monetary policy over the forecast period will be appropriate” going forward.

However, there are some signs that a move upwards from the current rate of 0.5% to 0.75% in May is, in the words of bond market guru Mohamed El-Erian “far from a done deal.”

“Ignore the split rate vote; the real news is that the Committee has chosen not to signal an imminent rate rise as clearly as it did last year,” Samuel Tombs, chief UK economist at research house Pantheon Macroeconomics said in an email to clients shortly after the decision.

The wording of the committee’s statement, Tombs says, is far less explicit than that in the Bank of England’s statement in September last year, the meeting prior to its November rate hike.

“Back in September—the meeting before it hiked rates in November—the Committee said it would hike ‘over the coming months’. Today, the Committee has not given any time-bound guidance,” Tombs writes.

The main reason for that change of wording, Pantheon’s note argues, is that recent economic data, while fairly solid, has not been as strong as the BoE had expected when it struck its hawkish tone back in February.

“The Committee’s confidence has been knocked by a “few surprises in recent economic data”, which we assume means the below-consensus PMIs, soft retail sales figures and February’s 2.7% CPI inflation rate, which was below the Committee’s 2.9% forecast,” Tombs says.

That leads him to the conclusion that a “rate increase in May still is under active consideration, but the likelihood is nowhere near as high as the 80% chance priced-in by markets before this meeting.”

As a result, Tombs forecasts that “activity and inflation data” will “surprise the Committee to the downside, ensuring that it waits until August to raise interest rates again.”

Two dissenters

Another reason to suspect that the bank may not hike in May as expected is the makeup of Thursday’s decision. The two members of the committee who dissented were Ian McCafferty and Michael Saunders, both widely known as the bank’s most hawkish policymakers.

Saunders and McCafferty tend to move in tandem, and the last time the pair of them dissented to the upside was in June 2017, five months and three meetings before the rest of the MPC came on side. Since last year the bank has changed its meeting schedule, moving to just eight per year.

The bank generally only changes policy on the day of an Inflation Report, as Governor Mark Carney holds a press conference on those days, giving the bank a greater ability to communicate its reasoning behind decisions to the markets and wider public.

With that borne in mind, should the MPC follow the pattern of waiting a quarter of its annual meetings to follow McCafferty and Saunders, it could be August — the first Inflation Report after May — before the BoE hikes, matching the forecast of Pantheon Macroeconomics.

To be sure, this is not a scientific way of working out when the bank will hike, but it might just turn out to be true.

Source: Business Insider

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Demand for new office buildings falls as flexible working reduces need for office space

The number of new office buildings built has fallen 56% since the financial crisis in 2008, as changes like flexible working reduce the need for office space, says Lendy, one of Europe’s leading peer to peer secured property lending platforms.

Only 2,300 applications to build new office buildings were approved last year*, down from 5,200 in 2007/8.

Lendy adds that applications to build new offices have also fallen since the financial crisis – down 58% to 2,500 last year from 6,000 in 2007/08.

Lendy says that the fall in the number of office buildings being built is in part a symptom of changing work patterns in the UK.

Flexible working, for example, has lessened the requirement for new office buildings as a stronger emphasis is placed on working from home. Recent innovations, such as shared workspaces and cloud-based co-working platforms, has reduced the need for employees to have their own dedicated workspace.

Lendy adds that the drop in new office buildings could also show that the former trend towards large business parks dominated by office buildings, is fading.

Low levels of bank lending to property developers has also hampered the construction of new office buildings. Bank of England figures show that in December 2013, over £34 billion in lending was outstanding from banks to property developers, but this plunged to just £14.8 billion in December 2017.

As a result of the lack of bank lending to property developers, more and more are turning to alternative forms of finance, such as peer-to-peer, to get more projects started.

Liam Brooke, co-founder of Lendy, says: “Modern ways of working mean that offices are no longer as essential as they may have been in the past.

“Formerly, rising employment figures may have signalled a requirement for more offices. However, there is now less need for offices as employees can, in many cases, work just as effectively from home or shared workspaces.

“Demand for new offices is still out there, but banks simply aren’t lending enough to property developers to allow them to get their projects off the ground. This is why we are seeing more and more developers choose alternative finance options to fund their projects.”

Source: London Loves Business

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Prudential Regulation Authority Stifles Buy To Let Mortgage Market

Recent attempts by the Prudential Regulation Authority to stifle the buy to let market have led to landlords finding it harder to obtain a buy to let mortgage deal.

63 per cent of the landlords aware of the recent changes have claimed that it is now harder to obtain a buy to let mortgage deal. Regulatory changes by the Prudential Regulation Authority have led to more stringent stress tests introduced in January 2017, whilst affordability tests for portfolio landlords were made stricter last September.

The research came from a recent survey by the National Landlords Association, which found that 70 per cent of all portfolio landlords, or those with four or more buy to let mortgages, are facing greater difficulty obtaining finance. This is likely due to the fact that lenders are now required to take into account how all of a landlords’ properties are performing financially when they offer a new mortgage deal.

However, it is not only portfolio landlords affected. 48 per cent of all landlords aware of the changes believe it has slowed down the finance process. Additionally, 46 per cent believe that the changes have reduced the available range of mortgage products.

CEO of the NLA, Richard Lambert, spoke out about how the changes are affecting the sector: ‘These findings show that the PRA’s changes seem to be greatly affecting the ability of landlords to find new finance and increase their portfolios. Given that the private rented sector now makes up 20 per cent of the housing market, it is vital that professional landlords are incentivised to continue providing good quality affordable housing to those who need it. This appears to be achieving quite the reverse.’

However, additional research from Money Facts found that there are now 2,052 buy to let mortgage products on the market. This is up from the 1,725 buy to let mortgage products available in September. They suggest that although the process of obtaining a new mortgage might be more complex, the availability remains.

Richard concluded: ‘Landlords looking to add new properties to their portfolios need to be conscious of the new requirements. We suggest talking to your mortgage broker or bank before committing to any new property.’

Source: Residential Landlord

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Land And Buildings Transaction Tax Limiting Scottish Buy To Let

The 3 per cent Land and Buildings Transaction Tax introduced in Scotland in 2016 is inhibiting the buy to let market.

Many buy to let investors have left the sector due to the extra costs associated with the Land and Buildings Transaction Tax. Two thirds have been discouraged from investing in a second property due to the additional tax and the staged withdrawal of relief on mortgage payments.

The latest quarterly property monitor report from Aberdein Considine found that existing landlords are also increasingly selling with the aim of reducing costs by reducing their portfolios.

According to Aberdein, the changes have lessened demand for homes in some parts of Scotland due to an influx of new properties on the market. Sales fell in 17 of Scotland’s 32 local authority areas during the fourth quarter of 2017.

Managing partner at Aberdein Considine, Jacqueline Law, said: ‘There has been a significant change in the Scottish property market in the last six months and it is gathering pace. By targeting landlords, politicians north and south of the border are squeezing one of the biggest and most powerful buying forces out of the Scottish property market, which is already affecting sales in certain areas. However, there are other parts of the country where an overprovision of stock could weigh down property values, creating a great market for first time buyers but really tough conditions for home owners looking to sell.’

Aberdein Considine warned that there will be a sharp decline in rental stock entering the market, raising pressure in the buy to let sector and pushing rents higher.

The report found that East Renfrewshire, home to affluent Glasgow suburbs such as Newton Mearns, was the most expensive place to buy property in eight of 12 months of 2017. Prices in this area remained just ahead of Edinburgh. Prices in East Renfrewshire were up by 4 per cent while in Edinburgh they were up 6.2 per cent. The highest recorded growth was 13.4 per cent in East Dunbartonshire. West Dunbartonshire followed closely behind at 12.25 per cent, whilst East Lothian and Lanarkshire came next with growth recorded of 10.8 per cent and 10.2 per cent respectively.

Source: Residential Landlord

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Pound-to-Euro Rate Forecast for the Week Ahead

Pound Sterling peaked at 1.1525 against the Euro last week after a combination of easing Brexit fears and continued expectations that the Bank of England (BOE) will raise interest rates drove the UK currency higher.

GBP/EUR rose up to the top of its long-term range but then lost momentum and fell back down to the 1.1430/40s, where it spent most of Friday plateauing.

Our analysis of the technical structure of this market shows the sell-off was prevented from going lower by the R1 monthly pivot at 1.1430, which has put a firm floor under the Pound which could underpin the currency over coming days.

Pivots are price levels used by professional traders to gauge the trend and as entry points for buy and sell orders; they therefore are likely to have an influence on future market direction.

When a falling currency touches a pivot it can often bounce back up.

The effect is exacervated by short-term technical traders betting on the bounce and thus adding to the buying pressure.

It is not surprising therefore that the exchange found extra support at the pivot and it is possible this could be a platform for a reversal and the pair to start going higher again.

This is our base case scenario since the short-term trend is still bullish.

In our last forecast we also talked about how the pair was now trading in between the 10 and 20 period moving averages (MAs) on the four hour chart, which was traditionally considered a ‘buy zone’, which means an optimum level to buy the asset and join the dominant uptrend (in expectation of higher prices).

We further noted that we were on the lookout for a bullish reversal candle to form inside the buy zone to provide confirmation of a resumption of the uptrend.

Although we did get a long green bullish candle developing in the buy zone, a ‘bullish engulfing’ candle pattern (circled above), it was followed by weakness and due to lack of follow-through, we consider it not a very reliable signal.

If another more reliable bullish candlestick were to form at the current level and in the buy zone between the 10 and 20 MAs, such as one of those featured in the illustrations below then we could forecast a move up to a target at the 1.1525 first, followed by the 1.1550 range highs/upper channel line.

The range highs will continue to present an obstacle to higher prices as it forms the upper limit of a band that has been in place for six months now (see pic below).

The ceiling of the range, therefore, will probably reject the exchange rate as it has done on multiple occasions in the past (circled in red above).

Nevertheless, there is also a possibility the pair could break out of the range altogether, but, for confirmation, we would ideally need to see a break clearly above the range highs.

Another monthly pivot, the R2, is situated just above the range highs at 1.1581, and it is likely to be a further obstacle to the uptrend.

Therefore, we would ideally like to see a break above 1.1620, for confirmation of a clearance of R2 and the start of an extension up to the next target at 1.1770.

This is the minimum price objective calculated using the traditional technical method of taking the golden ratio (0.618) of the height of the range and extrapolating it higher from the break.

On balance, we see a greater overall chance of an upside breakout of the range eventually, rather than a downside breakout, for reasons outlined in our previous article on the pair here.

Data and Events to Watch for the Pound in the Week Ahead

Overall it is a relatively quiet week for the Pound on the calendar and the most likely source of volatility will probably be the ongoing Brexit debate.

The Pound strengthened last week after a transitional agreement was agreed by the EU in Brussels, which will now see the UK extend its stay by 21 months after the March 2019 deadline, on special terms, whilst a comprehensive trade deal is hammered out.

Brexit headlines are of course impossible to predict as they are generated by politicians and we will be monitoring the newswires for any potential points of interest.

From a purely hard data perspective, the main release is the third estimate of Q4 GDP on Thursday at 8.30 GMT, although the consensus sees little chance of a change from the second estimate of 0.4% growth quarter-on-quarter.

“The more significant interest for next week’s publication will come from the national accounts detail released at this time,” says Investec of the GDP release. This will include revisions to data on household income and personal finances in general, which affect overall consumer spending, the biggest driver of growth for the economy.

Should growth be downgraded unexpectedly we would certainly expect a soggy end to the shortened week for the Pound.

Current account data for Q4 is also out on Thursday, March 29, at 09.30, and is forecast to show the deficit widening to -24.0bn from -22.8bn previously.

Traditionally the current account was always seen as a major influence on currency levels but now there appears to be little empirical evidence of a link, so we do not see much volatility arising from this release.

The CBI Distributive Trade Survey for March is out on Wednesday, Mach 28 at 10.00 GMT and will provide the latest data on the retail sector.

“Launched in 1983, this widely followed survey covers questions on sales, orders, stocks, general business situation, employment trends and internet sales,” says the CBI website.

Other March data includes Gfk Consumer Confidence, which forecasts to remain at a -10 reading the same as February.

Investec, however, sees a chance of a lift to -8 in March because of rising wages, less job uncertainty, easing inflation, the agreement of a Brexit transition deal and “the uncharacteristically “Tiggerish” Chancellor at his inaugural Spring Statement.

Other data in the week ahead includes mortgage approvals on Monday at 8.30, Nationwide house prices on Thursday at 6.00 (watch for a negative result as this would make two negative months in a row and be bearish for Sterling); business investment on Thursday at 8.30, consumer credit at the same time and mortgage lending also at the same time.

Data and Events to Watch for the Euro in the Week Ahead

The Euro showed vulnerability last week after manufacturing and services data for March showed a continued slowdown and it is against this backdrop of slowing growth than the currency will be assessed in the coming week.

The next major set of releases for the Euro is inflation out the week after next, with only Germany inflation out in the week ahead, on Thursday at 13.00 GMT.

German inflation is not expected to be representative of inflation dynamics in the rest of the Eurozone, however, so it may have limited impact, according to analysts at Nordea Bank.

“We caution against reading too much into German inflation figures out next Thursday as the Easter effect could distort the picture – this month to the upside,” says Martin Enlund at Nordea Markets.

Eurozone loan growth and money supply for February, meanwhile, are out on Tuesday, March 27, at 9.00. The former is forecast to rise by 3.0% from 2.9% in January and the later to remain at 4.6% – the same as the previous month.

Loan growth and money supply are important for the Euro as the indicate credit dynamics and more take up or availability of credit is usually a positive sign for the economy, and therefore the Euro.

A whole load of sentiment indicators is scheduled for release at 10.00 on Tuesday, including the final estimate for consumer confidence in March, industrial, services and economic sentiment in March and business confidence also for March.

Source: Pound Sterling Live

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Bank of England holds interest rates at 0.5 per cent

Although the Bank of England’s Monetary Policy Committee (MPC) has voted to hold interest rates steady at 0.5 per cent, it has also given strong hints of a hike in May.

The Bank said there had been “few surprises” since its last set of quarterly forecast last month, although it noted that inflation fell by more than it expected to a seven-month low of 2.7% in February.

The BoE raised the base rate for the first time in a decade back in November, taking it up by 25 basis points to 0.50%, citing inflation of 3% and the need to return the consumer price index to the 2% target.

Carney cited a robust global economic recovery and high inflation as the reason for the sooner-than-expected increase.

The Bank of England kept rates steady today but two of its policymakers unexpectedly voted for an immediate rate rise, in a statement that will boost investors’ confidence that borrowing costs will rise in May.

In addition, official data this week showing that British wages growth is catching up with overall inflation has cemented expectations of an interest rate hike to 0.75 percent in May.

Comments from Vlieghe and talk on transition follow Thursday’s Bank of England monetary policy decision, which was seen as providing confirmation that it will raise interest rates for a second time in May but lacking any meaningful signals of what might come after that. Last month the BoE forecast growth of 1.8 percent this year and next – well below Britain’s historic average – and last week government forecasts were gloomier, with Brexit dragging on the outlook.

McCafferty and Saunders said there was “widespread evidence” that spare capacity in the economy was largely used up and that pay growth was on the increase, presenting upside risks to inflation. The firming of shorter-term measures of wage growth in recent quarters and a range of survey indicators suggest pay growth will rise further in response to the tightening labour market.

All this accumulated economic data points to some easing of inflationary pressures following the crushing impact of the Brexit vote and the consequent hammering of the pound, pushing shop food prices higher.

The Organization for Economic Cooperation and Development forecasts annual growth of just 1.3% for the United Kingdom this year-a much weaker pace of growth than that expected in the U.S., Germany, France and Italy. In its February projections, the Bank of England said it expects inflation to remain above target for another year or two, supporting predictions for at least one more rate hike this year.

Ben Brettell, senior economist at Hargreaves Lansdown, says keep the champagne on ice for the moment.

In such exceptional circumstances, the MPC’s remit specifies that the Committee must balance any significant trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.

Source: Click Lancashire

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Edinburgh’s property market tops growth in UK

Edinburgh’s residential property market saw higher levels of growth than any other UK city last year, a report has claimed.

The average house price in Scotland’s capital increased by 10.2 per cent in December 2017 compared to the same time the previous year, while the value of the housing stock across the city grew by £7.5 billion over the same period – more than any other Local Authority district in the UK as a whole.

However, the £2 million-plus market was at its lowest level since 2004, Savills’s Residential Property Market Report found, hit by the Land and Buildings Transaction tax (LBTT), which would see £198,000 added on to the price of a transaction at this level.

Prime transactions for property above £400,000 reached a record 1,733 in Edinburgh, 15 per cent higher than 2016. Transactions above £750,000 increased from 247 in 2016 to 274 in 2017, driven by the southern hotspots of Grange, Morningside and Merchiston, which accounted for a total of 377 transactions last year, overtaking the traditional million pound hub of the New Town.

East Lothian, however, saw the number of residential transactions rocket by 17 per cent and the Borders by 12 per cent. Faisal Choudhry, head of residential research in Scotland for Savills, said: “Scotland has witnessed its strongest market since 2007, with price growth now outperforming London. Values will continue to rise due to a lack of supply and strong city economies.

“In particular, Edinburgh’s residential market profile continues to excel. The lack of supply and strong domestic and international demand for property in the Capital is one of the main reasons behind a rise in prime values in Edinburgh City.” The number of new build transactions in Edinburgh increased by 30 per cent last year.

Some of the highest sales volumes took place in the suburban locations of Liberton and South Queensferry. However, the strongest growth in transactions last year was witnessed closer to the city centre, where experts said the redevelopment of the St James centre had attracted people towards the city centre.

Across Scotland, the million pound market was described in the report as having made “a remarkable recovery last year”, following a slow start to 2017. The high-end property market has been hit by the introduction of the LBTT in April 2015, however, Savills said the impact was beginning to lessen.

There were a total of 173 transactions of £1m-plus homes for the year as a whole with 117 taking place in second half of 2017. This compares to 167 in 2016 and 289 at the peak of the market in 2007.

Source: Scotsman

 

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Changing face of the real estate market

The market in real estate is in a state of evolution, with the rapid growth of quasi operational assets such as data centres and logistics centres, as well as the occupation of more conventional assets, such as offices, on more flexible terms. The varying nature of those business models means that a bespoke approach to underwriting a loan on those assets is often required. New structures are emerging which are a hybrid between “classic” real estate finance and leveraged loans.

Evolution of the real estate market

Technology and disruption have affected a number of industries in recent years. However, it is only very recently that they are having a marked impact on the real estate sector (and, by extension, the financing of real estate).

The ever-increasing need for data centres and logistics centres are the most obvious tip of the technological iceberg, but are only part of the story. Demand for real estate is increasingly moving to a shorter-term, more flexible and adaptive model in other areas. Mixed-use developments are on the rise. In the residential space, the WeLive model provides accommodation with communal mailrooms and laundry rooms that double as bars and event spaces, as well as communal kitchens, roof decks, and hot tubs. The turnover of tenants is far quicker than the industry is used to, with the flexibility to stay for just a few nights (the Airbnb model), or a much longer period.

Equally, the lines between residential and commercial space are becoming more blurred. The exponential growth of wireless connectivity continues to result in an increase in flexible working, and serviced office providers; this is now also feeding into developments combining living and working sectors. One example is the Barratt London and SEGRO collaboration on the former Nestlé factory at Hayes in West London, which envisages a two-fold development of the site; urban logistics warehouses and modern industrial space on one hand, and homes and communal spaces on the other.

In all cases, the demand is for more flexible spaces, both in terms of the need to accommodate mixed use, and more versatile (often shorter) tenancies which typically results in less predictable income flows. All parties investing in, or funding the acquisition of, real estate, will need to adapt to this new model.

Impact on market participants

The systemic change in the real estate market gives rise to some key issues for borrowers, in optimising the debt component of the capital structures used to finance such businesses. For lenders, the key is ensuring adequate protection when advancing funds into a non-traditional business model. The change also impacts on sponsors, who need to consider differing approaches, to fund their acquisition of real estate assets.

We have set out below some of the key issues that we have seen arising in recent deals, that all parties should be considering at an early stage, to ensure that the acquisition and financing of these non-traditional assets, can proceed quickly and efficiently.

Key issues – and some potential solutions

Rental income

As explained above, one of the main changes arising from the current market trends is the requirement for flexibility. The knock-on effect of that flexibility is, of course, the lack of reliable long term rental income.

The absence of a long term contracted income flow has a consequential impact on the underwriting value that can be attributed to these assets. In order to ascribe value, lenders will need to look to the track record of a business and consider covenants based on its historic EBITDA; an approach which is more common in hotel deals. Additionally, lenders will need to consider whether there is any value outside of the contracts the business currently has with its tenants/users. For instance, a lender may need to take into account whether it can have some degree of confidence that alternate tenants could be easily found (for example, based on the asset’s location) or whether there are viable, alternative uses for the space.

Owner and operator

One of the other key themes to emerge is the rise in the range of real estate assets which require active management and are owned and managed by the same entity. Historically, owned assets were managed by an independent 3rd party operator, giving the lender comfort that a reputable, qualified and economically stable external party was managing the asset which the lender was financing. However, the growth of logistics businesses, serviced office providers and similar market participants results in a more complex business model. As such, the health of the assets is increasingly dependent on the quality of the operator.

Where the identity of the operator is considered critical, lenders may wish to deal with this issue by incorporating key man provisions or adapting the change of control provisions in their finance documents. In more conventional real estate financings, change of control provisions focus on the identity of the sponsor. In some parts of the market, sponsors are seeking to agree deals on the basis that a change of ownership will not trigger a mandatory prepayment as long as the incoming sponsor is deemed to be acceptable. Where the quality of the operator can have a material impact on the economics of a deal, change of control provisions may instead state that a change of ownership is permitted provided that the operator remains the same. Additionally, key man provisions requiring that particular individuals remain involved in the operation and management of the business are likely to become a feature of financings of these sorts of assets.

Flexibility

For assets where active management is crucial to performance, such as flexible workplaces and mixed use residential spaces, owners and operators will require finance arrangements that allow flexibility in relation to management of the asset. Operators will be keen to ensure greater scope than is available in more traditional real estate financings. This is relevant both to the types of actions that can be taken in relation to the underlying property and how cashflows are managed. Key issues for borrowers will include ensuring their ability to undertake a wide range of leasing activities or development works, to keep up with client demand and remain attractive in their markets. Borrowers will also need to focus on their ability to utilise a sufficient amount of their cash flows to meet the costs of such activities.

These types of businesses will therefore have a need for working capital expenditure in a way that is not required in relation to traditional real estate assets. Lenders will need to be cognisant of these working capital requirements, and the associated costs. They should therefore consider having provisions regarding the use of cashflow by an owner or operator, and the determination of excess cashflow amounts, which are less restrictive than would be expected in more traditional real estate financings.

Recourse

Another consideration for lenders will be whether or not loans advanced in relation to these quasi operational assets will be made on a non-recourse basis. Conventionally, real estate loans were advanced on a non-recourse basis because a lender is able to take a view on the value of the underlying real estate, as well as its ability to generate cash flows. However, loans made in relation to alternative assets such as data centres are often advanced on the basis of the credit of a corporate group and its business as a whole, rather than in relation to a single real estate asset. This approach is often taken because it enables lenders to mitigate their risks by lending against the wider performance and assets of a business and consequently, having claims against a greater pool of assets.

Access to funding

Securing debt facilities for the acquisition of more non-traditional real estate assets may prove challenging for private equity investors, because of a lack of lenders willing to fund against this newer asset class. In particular, it may be difficult where there is insufficient data or performance history to allow more conservative lenders to underwrite these loans. However, as a result, there are also opportunities for alternative capital providers to finance these assets, as they will have more flexibility to consider structures and assets which high street banks will be constrained from funding and for which investment banks may not have the appetite.

“Hybrid” financing structures

We are seeing a growing prevalence of “hybrid” loans, which take many of the asset value preservation features from a real estate loan, and combine them with the protection – and flexibility – afforded by a leveraged finance model.

In conventional real estate finance transactions, preservation of the value of the underlying asset is typically monitored by way of LTV and forward looking, lease contract based, financial covenants together with regulation of the maintenance of the property and conduct of business activities. Conversely, leveraged finance transactions focus on profit generating business activity and rely on covenants that measure a business’ earnings and cashflow, in order to provide adequate protection for lenders.

Market participants will need to carefully consider how their financing arrangements deal with issues such as appropriate methodology and thresholds for establishing financial covenants, what constitutes permitted distributions, the determination of excess cash flow and whether cash sweeps or cash traps will apply. Ultimately, these loans will need to strike a balance to give lenders the protection they require whilst allowing borrowers to access the money needed to finance acquisitions and ongoing working capital requirements, as well as the flexibility needed to operate their business model.

Our recent experience with “hybrid” loan agreements has seen a number of new trends emerging. Some features that have hitherto been seen less frequently in the European market, such as sponsor level guarantees, are being introduced to give comfort to a lender, where rental income generation is less predictable. Cashflow flexibility is crucial, with borrowers receiving far more control over accounts generally than would be the case in a more traditional real estate financing. Lender control over disposal of assets is also reduced, with borrowers more frequently having the ability to reinvest the proceeds rather than applying such proceeds in repayment of their loans. A more flexible approach to taking security (both in terms of timing and the proportion of assets to be secured) is also a trend that we have seen, again more typical of a leveraged finance transaction.

We are also seeing borrowers achieving greater flexibility in terms of what constitutes permitted activities. Provided that excess cash (after debt service) is used, lender consent may not be required for asset acquisition and capital expenditure, as long as certain financial metrics are satisfied. Occupational letting activity might also be permitted, provided leases are granted on arms’ length terms and subject to the effect on rental income.

The evolution of the real estate market continues apace, and we therefore expect to see an ever-increasing number of these “hybrid” real estate finance loans in the future.

Source: Lexology