I remember the first time I was asked to finance a ‘co-living’ asset. It wasn’t one that’s on the radar of the industry, not a branded operator. It was a sui generis asset that had been standing since the 40s and practically fully occupied throughout its existence with some of the residents in situ for many years. It had started life as a dorm and evolved into professionally managed HMO accommodation which had provided tenants a place to call home. The accommodation had small private rooms and shared kitchens. There were no additional amenities. Interestingly, it wasn’t a difficult asset to finance. The lender got comfortable with the quality of the borrower and the undeniable demand for the product.

Shared living has been around since well before we have all started talking about co-living, in the form of HMOs. In March 2018, there were almost 500,000 households registered as HMOs in England and Wales. This is not surprising. The financial and social aspects of HMOs are attractive at various life stages and these trends are driving the demand for co-living.

Some lenders are embracing co-living as the professionalisation of the HMO sector. Others remain to be convinced as to the demand case. Lenders have limited upside for getting it right but significant potential downside if they get it wrong and there are few other asset classes which are now viewed as so ‘alternative’ as co-living from a lending perspective.

So, let's start with the challenges lenders face in financing co-living:

  1. Policy H18 in the draft London Plan is the closest we have to a standard definition of co-living. However, so far, proposals being brought forward show no consistency on bedroom size, provision of kitchens, communal amenities, the level of service and length of tenancies envisaged. There is little evidence of up-and-built product that can be referenced for the level of the rents, operating costs and investment value. This creates uncertainty and uncertainty is ‘risk’ in a credit officers’ mind.
  2. There is currently a lack of specialist management expertise specifically catering to co-living which will satisfy institutions. In the student and build to rent industries, there are established ‘institutional quality’ management companies with demonstrable experience which is reassuring for lenders. The choice is much more embryonic in the co-living sector, although some of the specialist student management companies catering to 3rd party landlords are now moving into co-living too.
  3. The reputational risk that comes with dealing with people's dwellings is a live issue for lenders and investors alike. In the aftermath of the Grenfell tragedy, lenders require a higher level of confidence in the construction due diligence and ongoing management.
  4. Planning - From a lender’s perspective planning for co-living can be confusing. Co-living schemes may be brought forward as sui generis, C1 hotel use, C3 residential under permitted development rights, or even as large C4 HMOs. This is can present underwriting challenges for lenders who are often entrenched into use class credit policies.
  5. And if it doesn’t work out, what about alternative uses? There is potential for student or hotel use, but there is no precedent and a change of use might require an application to amend the S106, additional public contributions and potential loss of income.


So how can lenders get comfortable with financing Co-Living?

Lenders rely on the business plan to be delivered to achieve the income required to service, repay or refinance the loan. This income is a primary consideration to assess the transaction and loans are sized against the risk that the actual income can be maintained or forecast income achieved.

The leverage in the transaction is referenced as a debt yield (income/loan amount) or the reverse which is the debt to NOI (debt/NOI). The Loan to Value or Loan to Cost are also considerations.

Lenders will focus significantly on the operating strategy across all aspects of management – the marketing and letting up of the units, the day to day running of the asset, maintenance & regulations and reporting. If the asset is expected to generate non-contracted income beyond the residential rents, for example for events, catering, cleaning or laundry income, lenders might see this as speculative, unless the space is let to a third party or the income is fully proven.

Lenders are not in for the upside, they just want their money back with the returns they have promised their investors. They look for convincing investment strategies which address all the potential risks and sponsors prepared to stand behind their assessment.

The lending decision will be weighed heavily against the quality of the borrower. Existing relationships or the potential to build repeat business will be seen favourably as will the experience of the management team and the track record of the ‘capital’ in the transaction.

Often lenders in this asset class require additional forms of recourse to 'get comfortable’. Access to balance sheet recourse and/or cross-collateralisation to other assets is beneficial in accessing cheaper forms of financing.

The approach to construction risk is no different to BTR or student housing.

Lenders assess construction risk against the experience of the development team and the track record and balance sheet strength of the contractor. Well structured forward funding agreements, as well as good contingency and guarantee structures are potential ways to mitigate lenders’ concerns.

As the asset class is so new, it is very helpful to approach lenders with a valuation in hand. It addresses many concerns around rents, operating costs, valuation yield etc. Good valuers will reference the asset against residential schemes, serviced apartments, and student accommodation for both rents and operating costs. Whilst approaching lenders with a valuation is not something that happens for other asset classes, it is worth considering when it comes to co-living.

Whilst the traditional lenders are likely to be more conservative in approach, some of the newer providers are proving to be much more entrepreneurial, with regards to the risk and reward that they expect.

CBRE is able to offer specialist debt and structured finance advice and specialist valuation advice, to guide you through the complexities of raising loan facilities in this new and emerging sector.