During a conversation with Peter Clayton, Head of Property Finance at specialist lender Leumi UK, we gained Peter’s expertise on how Build to Rent fits into the company’s wider lending strategy, how a potential recession will affect the strategy, how the Environmental, Social and Governance (ESG) triangle factors into lending decisions, how the higher price of debt could affect the sector, and more.
Rising interest rates are presenting a challenge across the spectrum of industry. How is the higher price of debt likely to affect the Build to Rent sector, and how should developers be adjusting their strategy – if at all?
Interest rates can present an issue, but they aren’t an unknown quantity that people don’t know how to deal with. Higher rates are simply another variable that lenders must consider when analysing and appraising underlying Build to Rent funding opportunities.
Rates have been more volatile as of late and we’re readjusting to the impact that higher rates are having on the lending market. The impact has been significant, but in reality, Build to Rent benefits from a weight of capital, both on the debt and equity side of the equation, which suggests that it remains well funded, even with the higher interest rate environment. This is helped enormously by the undoubted increase in rents as landlords continue to benefit from a skewed supply and demand dynamic.
Expert knowledge of the sector is certainly a plus, but this knowledge is only partly useful if not applied correctly. It is how that knowledge is best used in terms of delivery of the right product, in the right location and at a cost that is sustainable and with a leverage that can be serviced from sustainable rents that counts.
I think the elephant in the room is the number of schemes that are part way through development, where interest costs in the development budget are looking a little thin between now and completion. There’s a question over whether rents have increased sufficiently to deliver enough interest cover for refinance with eases at completion and stabilisation.
Whilst we are starting to see stability, and the medium to long term horizon for interest looks more palatable, developers and sponsors need to question whether there is a refinancing or exit risk in the short to medium term – and if so, whether they have deep enough pockets, should equity injections be required.
Recent figures released by the Insolvency Service are making some creditors worried. How safe is Build to Rent compared to an industry such as retail or hospitality?
This topic cannot be looked at in isolation from residential ownership, which remains part and parcel of the UK psyche. Whilst I do remain convinced Build to Rent is a defensive sector because of the relative undersupply compared to demand, right now there is increasing rhetoric in mainstream media regarding declining house prices and softening mortgage rates, especially for first time buyers – which might just mean there is a change in the demand for Build to Rent in certain locations.
If house prices and mortgages become affordable (again), and the cost of renting continues to go up, then there could become a tipping point when Build to Rent rents must adjust too. We are not there yet and not expected to be either, but it is something we, as senior lenders, need to be conscious of.
In terms of how safe Build to Rent is compared to retail or hospitality, I think it really depends. The underlying product in the right location and at the right price point is critical across all asset classes. Retail and hospitality have had a torrid time for the last few years, and one could argue that everything has been relatively rosy for Build to Rent. It probably won’t be rosy forever, but we remain positive around the sector’s fundamentals.
How does Build to Rent fit into Leumi UK’s wider lending strategy?
Build to Rent forms a core part of our strategy but as part of a balanced real estate finance loan book. We have committed significantly to the market so far and remain optimistic around the sub-sector – but we will always analyse any opportunity on its own merits. Furthermore, Build to Rent is just one part of a strategy to grow our exposure to the residential sector in the UK.
Data coming out suggest that the UK will likely experience recession in 2023. How does this impact lending strategy?
My advice to lenders would be to stick to the fundamentals of lending in appraising the risks of each transaction on a case-by-case basis, whilst remembering that the market goes in cycles. Those Lenders that can work through cycles tend to secure the best clients for the long term – which is what we at Leumi are trying to do.
Leumi UK has been operating in different guises in the UK for 120 years and as custodians of this tradition, it is our job to ensure we support clients through tough economic periods but also protect the interest of our shareholders. We believe that recession also brings opportunity and as such believe that across sectors, including Build to Rent, we have a chance to work with people we wouldn’t ordinarily get the chance to do.
Sustainability has long been a watchword. How does this and other parts of the ESG triangle factor into lending decisions?
ESG is core to the decision-making process of any asset we look to fund, or any borrower we would wish to support. The concept of stranded assets is certainly prevalent in certain sub-sectors of the market, however with the funding of new stock we would expect ESG standards to be set ambitiously and for new build products to have a concept of being future proofed as part of their fabric.
It is interesting to note that Lord Deben, leader of the Climate Change Committee, has very recently come out and said that the market standard barometer, the Energy Performance Certificate (EPC), is not fit for purpose. I think this has been a widely held view of the market for some time, and whilst many developers and investors are ahead of the curve, those that have relied on EPCs as their proxy may well find they are behind the curve in the not-too-distant future. Given that equity investors into Build to Rent tend to have a longer-term approach to the sector, ESG must be integral to future-proof the assets and deliver a product fit for the discerning customer of the future – who will inevitably have an increasing eye on the topic.