The Development Finance Market

Ireland’s housing crisis has been a persistent challenge for the current government. In September 2021, the Government launched the Housing for All strategy as a direct response to Ireland’s failing housing system. It highlighted key issues impacting the market, from lack of both private and social housing supply, unaffordable housing to rent or buy, high construction costs, underutilised vacant housing stock and the low energy rating of the current housing stock. As we fast forward to Q1-2024, the same key issues remain, with new housing completions annually of c.30,000 units still somewhat adrift of the estimated national requirement of 50,000-60,000 units per annum. In a year which will potentially see a general election announced, housing will remain a key topic for all parties and regardless of the outcome, the supply challenge will persist.

Reflecting on 2022, approximately 30,000 units were successfully completed, facilitated by the deployment of around €8.5bn in development finance from both public and private sectors. The state played a significant role by committing approx. €1.4 bn in capital, constituting 17% of the total expenditure for 2022. In contrast, domestic capital contributed €2.4bn (28%) and international capital being the largest contributor with €4.7bn, accounted for the remaining 55%.

In order to meet an annual housing target of 60,000 units, a substantial financial injection of €18.5bn will be necessary (as estimated by research from PII). Based on this estimation, the State is anticipated to contribute €3.2bn, while the domestic market is expected to fund €4bn with international capital funding the balance of €11.3bn.

The Domestic Banks

As further mainstream banks in Ireland departed from the market in 2022, exemplified by the exits of KBC and Ulster Bank, the country is now left with only three major domestic debt providers – Bank of Ireland, AIB, and PTSB. The accompanying graph illustrates that PTSB currently lacks a development debt offering, while AIB and BOI each have less than 25% of their respective real estate portfolios allocated to development. Both AIB and BOI primarily concentrate on residential mortgages and commercial debt. In both BOI & AIB, their development debt is predominately focused on Tier 1 developers, including listed firms such as Cairn & Glenveagh, along with large private developers like Quintain. Their focus is on large-scale projects, effectively limiting borrowing opportunities for small to mid-sized developments and developers.

Ireland’s three high street banks’ loan books

The Established Alternative Lending Market

The limited availability of domestic funding in Ireland has paved the way for the emergence of the alternative lending market. Finance professionals have identified a distinct gap in the market, particularly catering to Tier 2 and 3 developers with small to mid-sized developments. These are generally high-quality smaller developers with good track records, a strong delivery platform with projects generally having the benefit of planning permission in place. These alternative lenders, primarily supported by international capital, channel their funds through lending platforms based in Ireland. These platforms adopt a streamlined and focused lending approach, ensuring swift decision-making processes and rapid deployment of funds to high-quality underlying borrowers.

Nevertheless, these alternative lenders offer terms that are relatively more costly than those provided by the Domestic Pillar banks. This is attributed to the demands of international capital, which seeks a robust and consistent return on investment.

Investors are also drawn to Alternative Lending Platforms by the diversification of risk, with investments being spread across various developments with a clear exit strategy, either via the private purchaser market or by social exit to an approved housing body (AHB). Terms for the latter are often agreed prior to commencement of the project. With investment being spread across various developers, geographical locations, exit strategies and timings, there is an inherent diversification feature that mitigates concentration risk that would otherwise be present when investing into a single development or developer.

Key controls within these platforms are the lending criteria and decision-making processes, which include criteria such as, maximum loan to costs (LTC), grant of planning permission prior to deployment of funds, analysis of project suitability, minimum profit the development is expected to generate, and proven track record of the borrower. All of which would be pre-agreed prior to any capital being committed from the platform to a development.

Despite the higher cost for the developer, alternative lenders have proven highly successful, leading to the establishment of numerous lending platforms in Ireland in the last decade. Well-regarded International capital such as Avenue Capital ($12.6bn AUM), KKR ($65bn AUM), and Pollen Street ($11.5bn AUM) support various development lending platforms in Ireland. Some support more than one platform in the same market, therefore diversifying their risk even further. It is noteworthy to mention Activate Capital, which has the backing of KKR but also holds the endorsement of the Ireland Strategic Investment Fund, underscoring a strong vote of confidence in the alternative lending market.

Snapshot of Irish based Alternative Lenders and International Capital providers

Alternative Lenders Deploying Capital

Development financing platforms provide the required levels of return to their investors through the effective recycling of committed capital. For instance, an international capital provider might allocate approximately €100mn of warehouse funding to a lending platform over a fixed term of approx. 5 years. Over this 5-year period, the €100mn can be utilized, repaid, and reinvested in various projects throughout its lifecycle. This systematic approach is the mechanism through which the platform generates returns, encompassing arrangement fees, exit fees, commitment fees, and a margin on the lending rate. For example, Castlehaven has deployed c.€2bn in development funding across 233 loans since inception, an average of €8.6mn per loan. The committed funding from the international capital provider is significantly less than €2bn. However, by effectively recycling the capital the lending platform is able to maximise the deployment during the fixed term.

Alternative Funding takes centre stage

As we look ahead to 2024, a year marked by potential political shifts and promises, one thing remains certain – housing delivery will undoubtedly take centre stage, regardless of the political outcome. The ambitious target of reaching 60,000 units annually demands a collaborative effort that goes beyond the capacity of the state or the large, listed developers, who, as a collective, delivered approximately 3,000 units in 2022. The magnitude of this undertaking necessitates an inclusive approach that involves all facets of the development landscape.

At this critical juncture, the role of alternative lenders emerges as indispensable. Their involvement is crucial not only in providing much-needed financial support but also in diversifying the sources of funding across different segments of the development spectrum. While the larger developers have a pivotal role to play, it is evident that the collective efforts of Tier 2 and Tier 3 developers will be vital in achieving the ambitious housing targets.

The alternative lenders are poised to play a pivotal role in bridging the financial gap, by extending their support to Tier 2 and Tier 3 developers and contributing to the overall diversification and resilience of the housing market. The focus on key urban locations is particularly significant, as it aligns with the broader goals of creating sustainable and vibrant communities where the demand for housing is most needed. Their ability to cater to unique needs makes them a valuable component of the housing ecosystem.

In summary, as 2024 unfolds with the potential of political change, the spotlight on housing delivery will only intensify. In order to achieve the housing targets, a concerted effort is required from all stakeholders. Alternative lenders, with their capacity to support Tier 2 and Tier 3 developers in key urban locations, are a crucial element in fostering a diverse, resilient, and sustainable housing market.