Bridge lending can be a dangerous game
A lot has changed since Lehman Brothers triggered the global financial crisis. Airbnb and Kickstarter may have democratised sharing homes and funding products, but while bank regulation has largely halted risky lending, you could argue that the can of financial risk management – rather than being kicked – has simply taken an Uber down the road, writes Shahil Kotecha, chief executive at alternative lender Pivot.
Taxpayers may no longer be on the hook for bank lending – regimes such as slotting mean they have to put too much capital aside. Citizens still are, however. Since the financial crisis ushered in quantitative easing, destroying bond yields, pension funds (effectively owned by the public) have had no choice but to shift their focus into higher-yielding asset classes. Many now back all kinds of financial managers with multiple exposures.
However, let’s bust the myth often perpetuated by ill-informed regulators that all property debt “is bad”. Without it, the property industry, and the wider economy, cannot function.
The case for debt
Many people conflate the pre-crisis malpractice (which concerned bonds and suspect sub-prime loans) with the regular practice of lending. This is somewhat understandable. Yet, as the co-founder of a property finance company covering bridge lending and development finance, I can say first-hand that as an industry we often don’t help ourselves.
While loan-to-value ratios have come down and development finance has been cut back, falling values and a plethora of emerging risks mean we cannot simply say “there’s 30% equity in this, all will be fine”. Often there isn’t. And with falling values rendering conservative LTVs more risky (in real terms), risk-averse lending soon starts to unravel.
Small is beautiful
For every highly leveraged site such as Quintain’s Wembley or Delancey’s East Village – which have an exit on the back of solid income streams – there are hundreds of smaller projects undertaken by developers who can’t borrow from a traditional bank. Many of them would be nowhere without alternative lending, now estimated at a fifth of our lending universe.
Last year alternative lenders wrote £6bn of new loans, of which 60% was sourced from insurance and pension funds, according to Cass Business School. An increasing amount of this funnelled down into short-term lending, which often finances development. Industry data showed £386.1m of bridging development lending in Q1 2018 – a 22% increase from the previous quarter.
The worry is that where lenders are shifting into development purely to maintain margin, they may be creating undue risk – particularly where they don’t have in-house development experience. However, there are a number of specialist lenders out there with the right development expertise in-house. Pivot is part of a wider group of businesses that includes an FCA-regulated investment platform, Propio.com, and Fruition Properties, a residential developer under the same roof. So when we underwrite a development loan, we can stress-test in ways a regular lender cannot.
Together with spiralling construction costs, insolvencies, currency shifts and potential chaos triggered by Brexit and Corbyn, there are the normal risks which have to be modelled. However, to properly underwrite a loan you have not only to understand and quantify these risks but be able to work out the chance of things going wrong, determining alternative exit strategies and the cost of putting things right.
A lot of lenders haven’t the first clue about any of those things and this is where problems will be building up. The point of taking these risks away from banks was that they didn’t have this quite specialised experience. It’s something we – and many other responsible firms – do have. In-house experience and the ability accurately to quantify construction costs and estimate “hope value” – what a site may be worth post-planning and the likelihood of gaining consent, for example – is crucial.
We set up our business originally to satisfy interest from investors in our development arm. This was spun out into a company now focused only on short-term finance. As we have seen, the market can only continue to grow and we need sensible competition to keep us all honest. What we don’t want is for everything to spin out of control once again. So it’s important financiers have competent underwriters – or it may be undertakers we need to carry property lending into the next cycle.