This article is sponsored by ICG Real Estate
ICG Real Estate has over €4.9 billion of real estate private equity and private debt assets under management across its five strategies: residential development, sale and leaseback, senior debt, partnership capital and private equity, with £650 million ($923 million; €756 million) having been deployed within the residential development strategy.
Jai Patel, managing director at Intermediate Capital Group, tells PERE that the time is right to double down on deployment. As lockdowns ease and the new normal settles, resident requirements will be different post-pandemic.
Where have you been focused recently?
ICG has multiple real estate strategies, I focus my time providing capital to developers looking to build housing across the UK. We focus on larger loans, typically funding developments of 200-400 residential units. As a result, we have the capability to underwrite larger tickets: our smallest is £30 million and our largest is £180 million. Most developments are delivering either single-family or multifamily housing, but we also look at the student housing, retirement living and co-living sectors.
Given our loan sizes we have focused in the South, including projects in London, Bristol, and Cambridge. However, we ultimately look for strong fundamentals – locations with good employment prospects, population growth and connectivity to amenity.
To date, we have deployed our capital across nine projects. Some of these projects are multi-phase and we are comfortable recycling sales proceeds into future phases, rolling capital through the development.
Why is the residential development market an attractive space for lenders?
House building is profitable. Most of the listed house builders have traded at a premium to NAV for some time. This profit margin provides attractive returns for lenders, but also acts as healthy margin of safety against the downside.
Secondly, the UK population has been growing since the 1980s – a trend which is forecast to continue despite concerns around EU migration. This, combined with the fact that the number of households are expected to grow, means we are funding housing stock that is meeting a predictable increase in demand.
Finally, our market is large, perhaps the largest real estate market in Europe. The value of UK housing is north of £7 trillion and it grows by around 1 percent per annum. This means we have lots of deployment opportunity, which provides our investors with a diversified portfolio of loans.
If population growth slows, how might this change the lending landscape?
I think it’s important to put the population growth in the context of housing delivery. There has been a well-documented under-provision of housing since the GFC, but we’ve not been building enough homes since the Thatcher era, when changes to government policy reduced public sector housebuilding.
From 1950 to 1980, the UK delivered almost 10 million homes despite its population growing only by 5.6 million. In the 30 years after 1980, 5.8 million homes were built against population growth of 7.3 million. Over the last 10 years since I’ve been involved in the sector our population has grown by 4.5 million versus 1.7 million homes delivered.
These dynamics have led to a demand-supply imbalance that will take 15 years to catch up even if we hit current government housebuilding targets. We still have plenty of homes to build, particularly the right type of housing appropriate for today’s society.
In terms of the lending landscape, the funding market was historically dominated by the UK banks. In 2007, residential development funding was about 20-21 percent of UK banks’ real estate loan books; today, it is 9 percent.
Banks have retreated away from development lending, largely due to the punitive capital treatments against construction loans. Alternative lenders have been growing market share and, as a result, have attracted many of the individuals who were initially underwriting these loans at the banks, myself included. You’re seeing more entrants that are either private equity-backed or sit within alternative lenders.
What challenges does the sector face in the future?
House price affordability is a challenge in the UK. The biggest constraint for buyers remains the size of a deposit and most buyers purchase with a mortgage. If a deposit is available through the ‘bank of mum and dad’ or other means, servicing is reasonably comfortable given where interest rates are. A meaningful rate rise would change this dynamic but I personally can’t see this happening any time soon.
Another challenge is understanding resident requirements. The pandemic and remote working have made people think about what they want from their homes. Adopting a “build it and they will come” approach may not work as well as it has done in the past and I believe resident requirements will become more demanding in the years to come, particularly as residents have more housing options to choose from.
Which types of residential development look strong?
For landlords that own build-to-rent properties, this type of income stream has proven resilient during the pandemic. I anticipate more development of professionally managed rental housing.
Purpose-built student housing has shown residential developers how quality new product can be widely absorbed by the targeted resident. Will the same rate of growth happen in build-to-rent? Either way, developers will look to de-risk against selling in the open market, particularly in locations where affordability challenges are present.
We will also see more repositioning or repurposing plays over the next 24 months where a housing led scheme will be the most viable option for that site (maybe a former retail pitch). In city center schemes, this will be a strong driver of pipeline as people choose to live in centrally located communities with everything on their doorstep. Forward-thinking developers have created fantastic communities. Kings Cross is a great example of how to build the right residential for the location.
I also like suburban housing. Employees by and large will not be required to be in the office five days a week going forward. Would you prefer to live in a two-bed apartment in Zone 2 London, or a four-bed house with a garden in Zone 6 going into the office twice a week? I certainly have a preference, though I suspect the answer may be age dependent!
Geographically, one of our strongest sales performers this year is our scheme in Bath, where you’re seeing cash buyers selling up London property and moving to a leafier environment looking for more space.
Will the end of furlough impact 2021?
The end of furlough will affect many industries. However, I view housing as an essential item. People spend the largest proportion of their disposable income on housing costs. It is the last thing that goes; do people want to move back home with their parents?
As lenders, if we wear the shoes of the target resident when assessing opportunities, we will get repaid on time with a healthy return (more frequently). We continue to look for new funding opportunities and will continue to walk the streets to make sure we are on the right side of the road.
What else is on the agenda for 2021? We are finally seeing strong momentum with respect to decarbonization in our sector – the “Greta Thunberg effect”. A sustainable approach to both construction and operating residential real estate needs to become the market norm, especially given the sector’s contribution to emissions.
There has been some good work by the likes of the UK Green Building Council, identifying the steps we can take as an industry to reduce emissions.
We are currently working on a product whereby as a lender we can incentivize the adoption of more of these steps to reduce emissions in the projects we fund. This is ultimately a good thing for all stakeholders involved and will, in time, generate greater value for all stakeholders.
How serious a priority should ESG be?
It has always been important for us, but we are now establishing even greater structure towards it. At some point within the next few years, every single investment vehicle will require structured thinking on each ESG area – investors will demand it.
Within the residential development market, momentum is growing, and the marketplace is big enough whereby we are exploring dedicating an entire vehicle to reduce the carbon emissions in our projects. The residential sector (including construction) contributes to c.18-20 percent of UK annual emissions.
By subsidizing the incremental cost of implementing green design changes pre-development we can encourage the adoption of tried and tested technologies and specific building methods, which will reduce operational and embodied carbon emissions meaningfully. This will future proof against changing regulation and match up to growing homeowner/residential landlord awareness and demands.
Take the example of poor-quality cladding; by being proactive you can mitigate against serious risks.
Our focus will be deploying capital with sponsors who are forward thinking about these issues, of which there is a growing list.
Case study: Triptych Bankside
The real estate division of Intermediate Capital Group provided a £177 million development loan to fund the construction of a 266,000 square foot mixed-use development on the South Bank in London.
The sponsor and project developer is JTRE, a pan-European developer and investor with a track record in large mixed use and standalone residential and office schemes.
Triptych Bankside is a mixed-use development comprising two residential towers, a low-rise office building, retail and cultural facilities. As part of the development, JTRE is also developing a new elderly care almshouse on Southwark Park Road which will contribute to the wider local community. Construction is scheduled for completion in 2022.