Development funding in the age of austerity
The free flow of capital which funded new property development across our markets until 2007 has ended. Although we are now fully four years past this market peak, the great deleveraging is still underway. We expect it will continue for a number of years.
The De Montfort Survey records only £20 billion of new lending to UK commercial real estate in 2010. Around £115 billion of refinancing is required to 2013/14. In this context, bank debt to fund new commercial property development is extremely risk-averse and can only really support prime schemes with pre-lets.
The crash originated in financial engineering of US consumer housing debt and went on to unravel the over-geared commercial property sector. The subsequent risk-aversion is inevitable, pervasive and enduring. We are clearly in an era of credit-rationing to the property industry. Recent surveys of bank lending intentions simply re-affirm that this constrained position will continue as re-financing or disposals greatly outweigh any new lending.
Some UK investment institutions view this lack of bank debt as a market opportunity. This is welcome, but may inevitably be restricted to the best opportunities in prime markets, as insitutions such as pension fund and life assurance companies are among the most risk-averse of investors.
Speculative development in Scotland is currently limited to very few prime city centre office blocks, small industrial schemes in strategic locations, former Enterprise Zones (EZs) and single-block retail developments in prime city streets. These highly selective schemes and pre-let developments in the supermarket and hotel sectors do not make a development cycle.
The private sector is credit-rationed and risk-averse, but the property development industry remains capital-hungry. Can public funding help stabilise our development sector and position it for future growth?
The ongoing fiscal consolidation to reduce the UK’s public sector debt provides a gloomy context. Capital budgets in Scotland are to fall by around 40% by 2014/15. However, there are some bright spots.
A new set of Enterprise Areas will be established in Scotland. Incentives will be targeted mainly at occupiers rather than property developers, and at areas and sectors with economic potential rather than simply those in decline. Our analysis suggests that the market opportunity will be to accommodate new and expanding companies rather than to engage in rampant speculative development as with the EZs of the 1980s and 1990s.
JESSICA funding via the Scottish Government, European Investment Bank and private sector partners will aim to invest then recycle money via economic development projects in qualifying areas. Our appraisals suggest that JESSICA will benefit some viable projects struggling to secure funding, but will prove too high a hurdle for many weaker projects.
Tax Incremental Financing (TIF) is expected to unlock development potential at a number of strategic projects, by borrowing against future non-domestic rates income to fund infrastructure. Our experience in advising clients in this sector confirms that there is need for market certainty around development potential in order for TIF to be viable. Larger projects awarded such as Ravenscraig, Leith Docks and Falkirk/Grangemouth, and strategic investments such as Fife Energy Park are likely to be typical of the emerging TIF market.
Other potential funding routes such as Local Asset-Backed Vehicles, Scottish Enterprise’s priority projects and regeneration via cross-funding echo the same themes of development certainty and clear economic potential. There are fewer pure regeneration initiatives such as Urban Regeneration Companies and more highly-focused, near-commercial initiatives.
Our view is that this combination of flight to prime by the private sector, and public funding shifting more to opportunity rather than need, will create an increasingly hierarchical market.
The downside of this is that many Scottish towns which historically benefitted from blanket public support and a rising tide of investment are now likely to struggle to secure meaningful new commercial development. However, it must be good for Scotland to invest scarce public funds in our best opportunities. There will be far less chance of developing the wrong schemes in the wrong places. And, as private funding markets re-structure and recover, our prime markets will stand to benefit not only from new private investment and new forms of public funding, but also from opportunities created by the lack of development since 2008.
For more information contact: mark.robertson@ryden.co.uk
