Property lenders need to take a more prudent approach post-Covid-19
James Liddiment, managing director in the real estate advisory group in Duff & Phelps’ London office, on how property lenders can survive the Covid-19 crisis…
Property development lenders will need to take a more prudent approach to property and development loans, both existing and new, in order to weather the Covid-19-linked economic recession.
According to James Liddiment, managing director in the real estate advisory group in Duff & Phelps’ London office, this may involve lenders deploying a range of strategies from reducing loan-to-value (LTV) ratios, reviewing debt recovery procedures, and giving greater weight to stress testing scenarios including sensitivities within the development cash flow.
“In simple terms, there are two obvious drivers to a problematic development from a lender’s perspective – cost overruns and subdued sales values,” says Liddiment. “Whilst there isn’t yet a body of evidence in the residential sector to support a reduction in value tone due to Covid-19, the pandemic has substantially impacted costs across the majority of sites due to construction delays and, in many cases, materials shortages.”
He points out that delays not only lead to increased costs in direct construction, but additional debt service costs, which can materially impact profit margins and give rise to default triggers under loan agreements.
In turn, developers will hope for increased sales volumes to offset the elongated development programme and, potentially, value improvement. Whilst valuations in the residential sector appear to be stable at this point, this is largely due to the absorption of pent-up demand and government stimulus in the temporary suspension of the stamp duty land tax (SDLT) up to £500,000. But Liddiment believes that further stimulus may well be needed.
“I believe there’s going to have to be something, otherwise as we approach the end of 2020 with increasing unemployment and the tapering of the government furlough scheme, by the time we reach the end of the SDLT stimulus, we could well arrive at a cliff edge, which may have a seismic impact on the market,” he says.
“As things stand, I think there’ll be a flurry of activity in the lead up to 31 March 2021, where home buyers try to transact in the absence of any extension to the stamp duty exemption. And we’ll really know where the medium-term residential market is at the end of the first quarter or start of the second quarter of next year.” Across the board, Liddiment has seen development lenders reigning in their LTV ratios on property developments.
Where a senior lender may have once offered a loan based on a 75 per cent LTV pre Covid-19, now they may be capping LTVs at 65 per cent in anticipation of market turbulence. “From a credit perspective it’s a prudent approach,” he says. “Particularly for projects which won’t reach practical completion until 2021 and beyond, where decisions to lend are underwritten on present day valuations.”
Since the easing of lockdown, Duff & Phelps has been appointed to deal with a rising number of restructuring and recovery scenarios “because lenders, particularly alternative lenders, need to proactively deal with problems due to their own funding structures – they can’t sit and wait,” explains Liddiment. In order to survive the next year, Liddiment says that property-backed peer-to-peer lending platforms need to do a “full review” of their loanbooks, while having conversations with borrowers at early signs of distress.
Detailed stress testing is also necessary for all property-backed P2P lenders and robust recovery solutions should be put in place with support from the correct professional teams. Liddiment adds: “Ultimately lenders and borrowers need to be alive to the fact that, although strong opportunities still exist and the world will keep turning, we remain in very uncertain times.”