How are changes in the construction market influencing debt financing?

Modular construction, contractor insolvency and lender appetite were among the topics discussed at a panel discussion on construction market changes and their impact on debt financing held by the Commercial Real Estate Finance Council on Thursday.

The panel discussed the following recent trends, among others, in the construction industry and how they are impacting on debt financing:

1. Modular construction

Stuart McEwan, of Currie & Brown, acknowledged the growing use of modular construction but queried how lenders view this construction model.

For Matt Pigram, partner at Maslow Capital LLP, modular construction is “something we need to wrap our heads around”. He noted that, in other industries, there have been significant technological advances in recent years but that the construction industry has not changed to the same degree. In the context of modular construction, he suggested that this might be explained by concern by funders about the often high up-front cost to be funded before delivery of modules and components to site.

Tarek Jumah, of Future Generation, commented that it is unusual not to have modular bathrooms, for example, in purpose built student accommodation. However, despite this, he noted that funders are still nervous about how modular construction is funded and insured and whether it will affect yields when a modular building is sold.

Macfarlanes’ experience is that developers and funders are beginning to recognise the benefits of modular and put in place structures which facilitate debt finance for modular. This is still clearly, however, a journey and adequate protections need to be built in.

2. Contractor insolvency

In light of recent high-profile contractor insolvencies, the panel commented on the renewed funder focus on performance security such as bonds and parent company guarantees.

Matt Pigram noted that funders will often inquire as to a contractor’s ability to procure a bond, treating this as an indicator of the contractor’s financial health. He commented that clients’ testimonials regarding contractors will also influence their decision to approve a particular contractor.

While the panel agreed that the strength of a contractor’s balance sheet will be a significant factor for funders deciding to lend, Tarek anticipates a move away from the traditional contractor model in the next 10 years with a move towards construction management procurement and more collaborative approaches generally. Whether this happens or not, we expect bonds and guarantees to remain high on lenders’ lists of concerns in years to come.

3. Lender appetite

The panel acknowledged an increase in the number of lenders prepared to fund construction projects. Matt Pigram referenced what he sees as a “re-emergence of mezzanine finance”. However, interestingly, he noted that mezzanine lenders have found it difficult to deploy capital given the presence of a significant number of senior lenders. He also commented that funding might be more expensive now given the heightened desire for contractors to put expensive performance security in place. However, there remains plenty of appetite to fund with some funders prepared to “move up the risk curve”.

In closing the discussion, the panel were asked for their outlook on the next 12 months for the construction industry and debt financing. A tightening insurance market, more complicated insurance terms and conditions and a greater need for specialist insurance advice were anticipated as some of the issues that will arise as well as more robust negotiation around cost and fluctuations if there were to be a no-deal Brexit.

 It will be interesting to revisit these issues in 12 months’ time to see how they have played out.