Forward funding coupon under downward pressure for best-in-class assets as competition intensifies

Institutional investors are increasingly prepared to provide upfront capital at more competitive rates than the banks to finance logistics and residential projects in a bid to get ahead of the competition as the weight of capital targeting these assets continues to outstrip supply.

In an interview with PropertyEU, Knight Frank’s European capital markets partner Mike Bowden said that institutional capital is getting more aggressive in an attempt to gain access to the sector.  

‘Historically, the coupon for forward funding structures has always been in line with bank funding rates or the in-going property yield,’ Bowden said. ‘But we are starting to hear about cases where investors are accepting lower coupons and occasionally, cases where investors accept zero coupon to get an advantage over the competition,’ he added.

Forward funding structures – typically structures whereby investors commit to buy a development and to finance it from its initial stages – have grown increasingly popular in recent years partly due to the lack of development finance but also to a shortage of existing product.

Under this deal format, the investor buys the site before the development commences and funds the expenditure as it occurs, receiving annual payments during the building phase. The developer is meanwhile obliged to procure lease agreements on pre-agreed terms. It generally also pays a fixed annual coupon in the range of 4-6% a year, providing the purchaser with a return on capital from day one.

Bowden: ‘However, we are starting to see investors providing a cheaper cost of capital in the case of best-in-class assets in competitive Western European capital cities. We are seeing this trend in the logistics market and starting to move into the residential sector.’

According to data from Knight Frank, forward funding has consistently grown over the past decade to represent roughly a third of all transactions in the residential space last year. ‘We saw a big increase in forward funding structures in 2020 and we expect this to continue in 2021,’ Bowden added. On a European level, forward transactions in the residential sector increased by 13% in 2020 compared to 2019, reaching €18 bn of deals or 32% of total European residential transactions.

This compares to €0.4 bn invested in forward deals in 2010, which equated to just a 4% share of the total European residential transactions.

Recent such deals in the residential space include LGIM’s BTR fund’s forward purchase of an £81.5 mln (€90 mln) mixed-use regeneration.

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