The art of securing development finance in today’s market is to “think like a banker.” At least, that is how one prominent European lender sees it. “Don’t make margins your priority focus,” says Peter Denton, head of the London branch for German bank Westdeutsche ImmobilienBank. “Banks will really appreciate a rounder approach of all the other aspects relating to development finance. Returns paid to banks will always be materially lower than your own cost of capital in this environment.”
Moreover, a pragmatic approach will go a long way. “Don’t make the bank do the thinking for you,” Denton advises. “Think about the realistic time a bank is going to want to build into its budget costs for leasing. Don’t try to sell a bank improving rents. They won’t base their views on this; they’ll base their break-evens on ‘what if’ distressed rents.” Denton continues: “Banks are going to want to see such things as cost overrun and interest shortfall guarantees to cover cost and leasing risks. Borrowers should also focus on the type of construction contract – for example, is it a guaranteed, maximum-price contract?”
Development opportunities are beginning to resurface in certain European territories, particularly in the London, Paris, and Warsaw office markets, but financing is not available for just anyone. Banks are concerned about who the sponsor is; by and large, it’s got to be a major player with extensive development experience.
Overall, it is the level of returns that can be made that takes precedence for lenders. Owing to Basel II regulation, which dictates that European banks must reserve greater amounts of capital against riskier transactions, development financing must generate better returns in order to justify that use of capital.
Given the restraints of Basel II, among other factors, European real estate bank Eurohypo believes fully speculative development effectively destroys banks’ appetite to lend. “One hundered percent speculative funding is generally not on most banks’ agenda, and the capital allocation methodology reinforces this approach,” says Michael Acratopulo, managing director of origination at the London branch of the German bank. “Some of the context may change if, say, confidence grows within credit committees or if spreads on investment loans fall significantly, but it is unlikely that the capital weighting will improve. For the moment, we do not consider there is speculative development appetite out there on any kind of scale.”
Seth Lieberman, chief investment officer of real estate investments at Italian asset management company Advanced Capital, and vice chairman of ULI’s U.K. executive committee, advises developers to make every effort to secure pre-lets and presales in order to significantly improve their chances of securing development finance in today’s environment. “It’s not that development debt can’t be obtained; it’s just that developers have to be mindful of the changing regulations on lending banks imposed by Basel II,” he says.
Acratopulo concludes: “To secure development finance in any capacity, I believe you need to satisfy the following criteria: a good track record and realistic leverage aspirations; a development scheme that makes sense in terms of physical delivery (i.e., the right type of space, specification, location); at least 60 percent pre-let and the right supply-and-demand fundamentals in terms of the unlet space; de-risked construction aspects through a fixed-price contract and a credible contractor/professional team; as well as the means and resources (both staffing and capital) to manage the project, especially if the business plan is not immediately achieved.”