WS Partner Ruby Giblin explains why builders are spoilt for choice by a plethora of post-pandemic funding models.
The investment cycle for developers, and in particular registered providers of social housing that are developing, has been completely transformed this year. Financing options have become more varied and the old model – of developing, charging, and then funding future developments with the proceeds – is no longer the default choice.
We’re seeing a new range of funding options and different kinds of housing product come to the fore as a response to the unprecedented challenges which the industry is currently facing. There is a lot of new information to understand, and that comes with risk attached. But for those who are prepared to navigate the unchartered waters, opportunities abound in a new and more diverse world.
New games in town
Covid-19 has accelerated change, but there are a number of more nuanced drivers behind the shift in lending practices that we have seen over the past 18 months – from the cost of environmental retrofitting and cladding remediation, to the introduction of new affordable housing models such as First Homes. These trends also sit against the backdrop of an overall fall in development volumes caused by the pandemic and Brexit, exacerbated by shortages of both materials and people.
The cladding crisis, in particular, means that many significant high-rise assets are no longer chargeable at economic rates, or at least require expensive remediation. Environmental retrofitting poses a similar problem – high numbers of buildings which were once robust and reliable may start to look increasingly costly. The appeal of charging assets is usually that the proceeds go into the next development, to create new assets to charge; but in these cases, the money risks being swallowed up on the next round of remediation and retrofitting.
In response, the different funding solutions from potential lenders need to be diverse. For those willing to look at less common avenues of funding, there is still investment available.
Unsecured lending is one such model. While there will usually still be an unencumbered asset test, this should give access to a wider pool of options (including properties that are traditionally difficult to charge). It will also remove timing constraints and reliance on local authority departments, as well as reducing the cost and expertise needed to manage the charging process. Unsecured lending is slowly increasing the traction of capital markets investment too. For instance, retail charity bonds for RPs, which may be unsecured, and euro medium term note bonds, which – like private placements – are particularly attractive to overseas investors and have added to the flood of North American interest.
For-profit RPs are also significant here, having introduced an equity-based model to the social housing sector which previously didn’t exist. For-profits doubled their units this year to some 20,000. While that is still small, it’s an interesting look into another model of funding which doesn’t always rely on charging assets.
The critical point to take away here is choice. The challenges facing the sector are multiple and varied, so funding models have to be as well. We expect disruption to continue in the coming years, and so more innovation will be needed as we adapt.
If remediation and retrofit have been the major disruptors of the past year and a half, then the next great challenge will be the increase of ESG regulation. Following the publication of the government’s sustainable investing roadmap last month, this will be an increasingly crucial part of development in 2022 and have a major impact on lending and borrowing.
The roadmap will require all entities, including developers and RPs, to start making sustainability disclosures. Solid and demonstrable ESG credentials will become mandatory, and most sectors are still getting to grips with exactly how to prove them. Having an established track record and focus on social value, along with a sector-wide reporting framework (the Sustainability Reporting Standards) means many RPs are arguably closer to being able to do so than other developer peers. However, with the roadmap promising a new framework for all borrowers to demonstrate environmental and social value, there is still uncertainty in the air – something that is never good for lending.
This is a risk, but once again the solutions may be found through innovation. An emerging front-runner is modular building, with new technological advancements set to come forward, particularly around modern methods of construction. There are two major RP portfolio deals happening currently, and momentum is building behind modular as a way for housebuilders to secure investment from lenders while giving them the confidence that the product can be labelled sustainable going forward.
MMC lends itself perfectly to the requirements of regulated funding models. It has strict and prescribed technical requirements (which valuers have now carefully refined), allowing objective and comparable tracking of things like energy usage and waste, carbon emissions and supply chain visibility, all of which are attractive to funders.
Guidance from the Loan Market Association and the International Capital Markets Association also suggests that modular-built housing, being typically energy efficient and increasingly used to build affordable housing, should have natural synergies with sustainable finance. RPs and developers should however remember that the roadmap is clear such measurements must be meaningful and quantifiable for finance to be genuinely sustainable. The entire lifespan of a product and its ESG credentials must also be thoroughly considered, to avoid allegations of greenwashing. Opportunities exist; but these things have to be taken seriously.
Change for the better
Rather than the old world being under attack, we should look at the current funding landscape as an evolution. The demands on RPs and traditional developers in the current climate are more complex than ever – one thing we know about the next decade is that one size will no longer fit all. New and more diverse funding options will only help to keep businesses running and to make sure homes are built. If that’s the result, then the more the merrier.