The Evolution of Property Funding
In the property development sector, we’ve recently seen an increase in alternative lender activity. While pillar banks are present in this market, a large number of transactions require more leverage than these banks can provide. As a result, alternative lenders have moved into the market.
The Irish lending sector, which was previously dominated by pillar banks such as AIB, Bank of Ireland, and Ulster Bank, has undergone a remarkable transformation since 2008. A smaller traditional banking industry has formed, with fewer active firms and a much lower appetite for risk. This is only getting smaller as KBC and Ulster Bank leave the Irish market. This has created a financial shortfall, particularly in the Irish property and SME sectors.
The Irish lending landscape has been influenced by shocks to the Irish economy such as the 2008 global financial crisis, Brexit, and, more recently, Covid. Ireland has experienced the rise of new sources of funding from alternative lending providers in the aftermath of the global financial crisis. Several reasons have contributed to this shift, including the exit of banks from the Irish market and the winding down of specific institutions.
Furthermore, authorities across Europe have imposed stricter regulatory requirements, such as greater capital ratios for the banking sector. This has limited the amount of money available for lending. Stricter lending standards and lower lending levels have combined to reduce credit availability in some sectors of the economy.
A number of alternative lenders entered the Irish market in response to the shortfall in available lending. While a relatively new phenomenon in Ireland, this follows an already established trend in the US and the UK, where borrowing from non-traditional lenders would not be seen as unusual. Alternative lenders are often able to execute quickly and be flexible on structure, something traditional banks may struggle with due to regulatory and risk restraints. Greater capital-holding requirements, as well as existing exposure to weaker sectors, are now limiting the ability of traditional banks to lend, particularly for riskier assets like hotels, offices with short-term lease risks, and residential construction.
Commercial real estate
In the sub-€20 million commercial real estate market (CRE), financing is plentiful. The pillar banks are active in this space for deals involving strong tenants in stable sectors and extended leases with LTVs of approximately 60%. However, when the leases are short or expiring, and the LTV is greater than 65%, they face difficulties. Alternative lenders are particularly relevant and adaptable in addition to these criteria. Transactions are being completed with an LTV of 70% or higher, while interest charges are larger than 5%. This may jeopardise an asset’s ability to service its debt, resulting in interest-only payments in the future.
If value can be added to the asset through active asset management of leases and/or capital spending to upgrade the property and shift it into a higher rental band, this approach to borrowing can be a worthwhile strategy. However, the borrower may be required (by the lender) to meet specific milestones within certain timeframes.
Irish SMEs borrowed almost €4bn from non-bank lenders between 2019-2020, across a wide variety of products.
Tighter regulation has seen traditional banks cede market share to alternative lenders over the last decade. While the addition of new providers is a positive development for businesses, traditional bank lending continues to account for the vast bulk (approximately 90%) of lending in Ireland. Nonetheless, as a result of the effects of Brexit and Covid, alternative financial providers have become more well-known, a trend that will certainly continue in the future years. Some lenders’ risk appetites will be satisfied by the qualities of a transaction, while others will be turned down. Alternative lenders follow a strict set of rules.
The three main uses of property-related finance from alternative lenders are:
- Investment property acquisition
- Residential investment/buy-to-let
- Development finance and land acquisition.
These forms of lending are explored in more detail in the following sections.
1. Investment property acquisition
Residential investment/buy-to-let, commercial office, industrial/logistics, and multi-unit private rental sector projects are all included in the definition of an investment property.
2. Residential investment/buy-to-let
For straightforward residential investment/buy-to-let transactions the pillar banks are the most competitive. From a regulatory standpoint, an individual can borrow up to maximum 70% of the property’s value (LTV).
In this sector, alternative lenders are typically regulated, originate loans for securitisation, and are only accessible through the mortgage intermediary network. In comparison to pillar banks, they are relatively competitive.
Unregulated lenders are also operating, albeit with a lower volume of transactions and at a far higher cost than regulated lenders.
Recent numbers issued by the Banking & Payments Federation of Ireland state that buy-to-let investors account for barely 1% of all mortgages taken out. This compared to 20% in 2006, demonstrating the extent to which private landlords have left the market and how property funding has evolved.
3. Development finance and land acquisition
Development financing has generally shifted from banks to alternative lenders, reflecting market risk and the difficulty in obtaining such finance. Alternative lenders now provide almost all the funding for land acquisition.
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