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Finance dearth stores up office construction woes

By Andrew Macdonald and Sinead Cruise LONDON, May 10 (Reuters) - Jittery lenders and hefty margins on central London prime office construction finance may stunt speculative building until 2014 and stop developers from timing projects to coincide with an anticipated sweet spot in rents. "It's the easiest thing in the world for a bank to just say no to development loan requests... Most banks used to lend like every deal was a safe bet. Now many of them won't lend a penny to developers," said Solly Benaim, head of real estate at BDO. The global financial recession saw many London developers postpone or cancel prime office projects as unemployment rose, while rents and construction costs fell. Now, they want to kickstart projects, but lenders remain wary of the risks. Savills' commercial research head, Mat Oakley, is advising clients that 2011-2014 promises to be a boon for landlords keen to let prime offices to space-hungry companies that are growing on the back of economic recovery. "Lenders' caution and the almost non-existent development pipeline almost everywhere in the UK is not an ideal situation for UK Plc because the economy will recover and businesses will grow," Oakley told Reuters. Lender wariness is seen in the high margins for construction finance.

Experts said loan-to-values of 50 percent would likely have margins of about 175-375 basis points (bps) over LIBOR, those on 65 percent LTV reaching 200 bps-plus. "It takes hundreds and hundreds of millions of pounds to build some of these schemes but I can't think of any banks willing to contemplate development loans in excess of 75 million pounds ($114.3 million)," one senior UK banker said. Capital adequacy rules for banks, in accordance with Basel II controls, are designed to discourage risky development lending, and have made it near impossible for banks to give finance on large-scale construction projects without a significant number of pre-lets. "Some people have accused us of withholding funds from the market. The fact is we couldn't lend (to speculative projects) even if we wanted to," the senior UK banker said. Nick Berry, a partner at property fund manager Mountgrange Investment Management, said: "They are picky about the sector, the sponsor, prelets and the covenant. A developer really needs to tick all those boxes before they can be confident about securing the debt they need." STORING UP TROUBLES Chris Vydra, a partner at property advisor Knight Frank, said new office supply in the City would remain at historically low levels for at least another two years. Experts are forecasting the delivery of about 1-2 million sq ft of prime office space a year in the period 2011-2014, against average annual demand of about 4.5 million sq ft, effectively serving to lift rents and suppress vacancy levels. Vydra expects normal rents to hit at least 52.5 pounds ($81.20) a sq ft by end-2010, up 19 percent from about 44 pounds in December. "At the end of last year, some people thought that (forecast) was totally unrealistic, but we might even be a little light on that estimate," he said. Some developers are already hawking their plans around banks with a view to getting finance for construction or refurbishment work, and Savills' research shows some are tentatively in the market to provide this, at a price. It lists Barclays, Close Brothers, HSBC , Eurohypo, Lloyds Banking Group and Royal Bank of Scotland as potential sources of finance. Developers wanting to time their re-entry into an improving market are also mulling other options, including joint ventures, syndicated loans, fund raisings, and forward-funding agreements. "To get your partner signed up, you're going to have to have a very convincing story and as much certainty on price and construction costs as you can," said BNP Paribas' Dan Bayley. If successful, these developers may cause a wave of project completions at the end of the 2011-2014 sweet spot. "If in the 2012 to 2020 period you get... an unsustainably large bulge of completions, that could be triggered by developer fervour and easing of banks' risk aversion, you may see exactly the same pattern you saw in the late 1980s, early 1990s," Oakley said, referring to that supply glut and its knock-on effects. While this bleak foretelling will not be lost on some proactive REITs and developers -- among them Land Securities , British Land, and Helical Bar -- who will remain on the sidelines until a prospective tenant gives the green light for building. That may take some time. "Some clients are acutely aware of how far they need to plan ahead for their real estate needs, others have to be told they need to wake up and smell the coffee," Bayley said. (Editing by Mike Nesbit) ($1=.6564 pounds) (See www.reutersrealestate.com for the global service for real estate professionals from Thomson Reuters) Keywords: CONSTRUCTION FINANCE/ (Reuters Messaging rm://andrew.macdonald.reuters.com@reuters.net; +44 (0) 20 7542 9667) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved.

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