Banks increasingly cautious to invest in RE projects in the Baltic States

Banks increasingly cautious to invest in RE projects in the Baltic States

Lately, the financing by banks of both low-scale commercial real estate (RE) projects of developers and acquisition of objects generating higher revenue has been more conservative as compared to the situation last year. This trend has had an adverse effect on the already low market liquidity in the Baltics, while the developers search for alternative sources of financing.

“The banks have become more selective in choosing the RE projects they want to invest in, and some of the aspects that influence this situation are a decreasing return on investment and growing financing costs in the Baltic States. The capitalisation rates are below the 6 per cent threshold, which is a psychologically crucial barrier for the banks, who value pricing at somewhat more conservative level – at no less than 6.5 per cent. This means that they allocate a lower value to the same object than the market. The approach of a bank and market participants to the objects generating income is different; therefore, the financing is more conservative than the market participant would like to see,” said Bernardas Velikonis, a consultant at Newsec, an international real estate advisory company.

According to him, the lending conditions have also been aggravated by the competition in the banking sector, as well as the banks’ approach holding that the market is currently at the top of the economic cycle, which will be inevitably followed by stagnation. It also seems that the RE segment has reached the ‘ceiling’ of concentration in the banks’ portfolios; therefore, the banks are more prone to refinance the current RE loans and cautiously evaluate the option to finance new projects.

However, despite the deteriorating lending conditions, the majority of the projects still find their investors – larger banks are currently able to choose larger projects involving a lower risk, while smaller banks undertake somewhat more risky and lower-scale projects.

No changes in conditions for larger developers

The expert explained that despite the deteriorated conditions, the banks grant rather generous loans to the developers of larger-scale projects. The financing of higher-risk commercial projects creates more space for smaller banks or niche players, such as the crowdfunding platforms.

“Even though in the past years there have not been any significant changes on the global financial market, the markets of the Baltic States demonstrate an obvious trend where local banks ask the investors to contribute a higher share of the equity capital, whereas the bank margins keep climbing. Thus, it appears that the consolidation of the banking sector and reduction in the competition have had a negative impact on the lending conditions,” stated Velikonis.

Residential RE is the most attractive

According to the expert, the banks and investors have a different approach towards different types of real estate: “The banks are more prone to grant financing to residential RE, while they act rather conservative in respect of hotels.”

Velikonis clarified that such an attitude towards hotels had been shaped by the negative experience of the Scandinavian banks, where during the time of crisis, these banks incurred tremendous losses, and thus refused to grant loans to the new hotel projects in Lithuania, or offered loans on particularly conservative conditions.

“Nevertheless, the general trends demonstrate that the majority of new projects in Vilnius with reasonable opportunities are able to get the necessary financing. Meanwhile, the banks in Kaunas are more careful about new office development projects, since they wish to make sure that the demand corresponds to the growing supply. However, the banks continue granting loans, though maybe with more caution and higher contributions from the developers,” he added.

Crowdfunding as an alternative to conservative banks

The expert emphasised that because of the loss of competition in the banking sector in the Baltics, the local platform for alternative investment on the market is particularly welcome.

On the other hand, it is for a good reason that the crowdfunding is called an alternative investment platform, since it demands higher loan interests and thus requires to assume higher risks.

“The local crowdfunding market is still in its early development stage, whereas in Estonia, it is much more advanced, while in the United Kingdom is it an equivalent alternative source of financing of higher risk projects. The investments by natural persons start at 100 euro there, which means that participation is possible even with minimal capital,” said Velikonis.

According to him, crowdfunding is an excellent alternative in this environment of low-interest rates, granting an opportunity for natural persons to invest their funds and receive a higher return.

“The market presents only a few players of this kind, who, however, already have their own segment of users resembling that of smaller banks, which commonly attract less experienced developers. The outcomes and more certain perspectives of crowdfunding will depend on the quality of the projects invested in and how carefully the creditworthiness risk of a developer has been assessed,” explained the expert.