As the credit crunch bite,s it's time for new investment vehicles to bring money into big projects
The current deep freeze in the world credit markets and the deflation of property as an asset class will have considerable consequences for the regeneration market.
Research is quite clear that the primary aim of the private sector when investing in regeneration is to achieve rental and capital growth. In the current credit and capital value environment, it is likely that both of these aspirations will prove more difficult to attain. There are also some signs that retail occupier demand is weakening and UK house price falls may depress consumer spending, ultimately reducing demand for retail space and private city centre flats (key components in regeneration schemes).
Banks are key investors (both in debt and equity) in the regeneration process. They are generally now “hors de combat” so far as new lending goes. This is important as, banks have traditionally seen many schemes through the planning and development phase, when risk is relatively high and return low. It may be some time before they come back into the market with any intensity.
Despite these macro economic problems, regeneration remains a critical social and economic need and is central to government policy.
It is therefore critical that we reinvigorate and incentivise the private sector at this pivotal moment.
With potentially less money available from the private sector, aggressive and co-ordinated public sector policy is needed to encourage more private finance both to move into, and stay in, the regeneration game.
Money spinnersSome potential solutions should include:
• The “souping up” and simplification of the grant regime
• The government also needs to look at tax incentives (which are already partly in place for the decontamination of land), to incentivise private investment. The US system of tax incremental finance (TIF) has been suggested as an appropriate model. Despite the government's reluctance to hypothecate taxes, ring fencing and hypothecating them for specific regeneration projects may well make very good sense.
It is critical that we reinvigorate and incentivise the private sector at this pivotal moment
• Unified, fully empowered regeneration authorities need to be drawn together, akin to the Docklands Development Corporation of the late 1980s and early 1990s. David Milliband complained in his speech to the British Urban Regeneration Association conference in 2005 that there were too many agencies and the process of regeneration was too fragmented. It is time that that complaint was turned into action.
• The government should seek to bring in legislation (possibly by way of amendment to the Real Estate Investment Trust legislation) to allow for the creation of regeneration investment vehicles (RIVs). These would be on shore property trusts, akin to REITs. They could also benefit from the necessary tax incentives to stimulate regeneration (eg TIFs).
They would end the need for the hybrid structures, such as Jersey Unit Trusts with limited partnerships underneath them, which are designed to deal with the transfer tax problems of limited partnerships and the management issues of offshore trusts. The UK property industry should not have to create a byzantine part on/part offshore vehicle simply to achieve regeneration with commercial efficiency.
The government needs to help here. The RIV was suggested in research findings published in April 2006 by the Investment Property Forum and the IPF Education Trust and it is time that report was taken seriously.
• With the debt markets in difficulty, and the flight to high quality and government securities in full flow, there is a need to look for alternative sources of funds for regeneration projects. Despite the current battered state of the world bond markets, it is possible that a central (or, more likely, because of Public Sector Borrowing Requirement problems) a local authority backed bond might attract longer term financing to regeneration projects. These may be attractive if they can show a coupon which (perhaps a pool of) local authorities guarantee. Such bond issues might help the regeneration process through its early and most difficult and high risk phases: decontamination and infrastructure provision. This may seem an unlikely long shot now, but should not be ruled out as credit markets loosen.
Regeneration - a safe bet?It is worth noting that there is some evidence that regeneration areas enjoy a cushioning effect during downturns, due to the availability of grants and other public finance. The long timescales involved in regeneration projects may also be an advantage at the moment. The projects may be delivered as the property market begins to swing up again. Some regeneration funds, such as English Cities and Igloo, are beginning to perform well, as the “turbo-charging” effect of the recent boom drains out of, for example, offices and out of town retail indices.
Some academic research also indicates that returns from regeneration investment may be stronger than in the general market. However, more work is needed in this area to completely substantiate the case. What is true, is that easy returns based on yield compression in the wider market are now not available. Regeneration will offer an interesting alternative, as part of the wider allocation of investment to assets by institutions.
The industry's challengeThe industry needs to pick up the government's regeneration gauntlet. In his 2005 speech to BURA's conference, David Milliband said that he wanted to unlock billions of pounds of regeneration funding from the mainstream departments: "all departments, not just the ODPM (as it then was) should be regeneration departments". He went on to say: "Help us champion the formation of joint ventures between private, public and voluntary organisations."
It is the government's challenge to deliver on those promises and to incentivise the regeneration market at a time of some difficulty. It is the industry's challenge to respond to that incentivisation and to help the government deliver world class regeneration schemes to make people's lives better. There is no more urgent or apt challenge for the property industry.
Bruce Dear is head of the real estate investors group at Eversheds