Mortgage rates have also climbed since interest rates began rising in 2022, reducing affordability and putting home ownership out of reach for many young families and early-career workers. Many are forced to rent instead, and rental supply is equally tight in much of Europe, exacerbated by this excess rental demand from people priced out of the homebuyer market.
Despite this ever-increasing demand, major banks are stepping back from real estate development lending, struggling under rising capital charges and the more stringent monitoring requirements for this kind of specialized lending.
Specialists Step In: The Role of Private Credit
Specialist property lenders are stepping in to fill the gap left by retreating banks, providing flexible financing for small- and medium-sized homebuilders across Europe. Private credit providers are increasingly supplying these development lenders with the needed capital, and we see attractive opportunities for investors.
These investments can offer strong return potential and are ultimately secured by tangible assets. Lending is determined partly based on loan-to-gross-development value (LTGDV). That’s an estimate of how much residential units will eventually be worth on the open market as a percentage of the loan amount, typically 60%–70%. We think this provides strong downside mitigation and a cushion against cost overruns, delays and the possibility that finished units pull in less than expected.
The funding sequence can also be favorable for lenders, because the real estate developer typically contributes its full equity portion up front, with the development loan funding the rest of construction. Because less than the total loan amount is needed at the beginning, the actual day one LTGDV is lower than the headline figure for the entire loan. As the project moves along, lenders disburse the rest of the loan amount gradually—but based on specific milestones. Typically, the maximum LTGDV is reached only after the housing is completed.
Added Fundamental Support from Shortages of Housing Supply
Meanwhile, supply shortages across Europe’s countries add fundamental support to lending conditions. Germany’s previous government, for example, has failed on its 2021 pledge to build 400,000 new homes per year to ease the country’s housing shortage. In 2024, it managed just 225,000.
In the UK, the cumulative new home deficit is more than 1.3 million, according to the Centre for Policy Studies think tank, with high interest rates suppressing volume.
Cashing In on the Complexity of Loan Structures
But loan structures and project operations can be complex, so lenders need tailoring, not templates.
For one thing, the borrower only taps into the loan in stages as building progresses. Also, interest isn’t paid monthly over the entire loan term—it’s typically paid only at or near the end, from sales of the newly built homes and apartment units. As a result, these payment-in-kind loans can’t be pooled into securities, so banks or other lenders must hold these assets on their balance sheets or in private funding structures.
Projects can also be unpredictable. For instance, construction slated to take 12 months may stretch into 18 or 20, necessitating loan extensions. In extreme scenarios, a lender might have to step in to replace a construction company mid-project if the original developer runs into trouble.
As we see it, private specialist lenders are often better equipped to structure these bespoke financing arrangements and conduct the type of “high touch” underwriting and asset management necessary to finance various types of home construction.
More Than One Way to Invest
The opportunity set for private lenders, as we see it, is as wide as the shortages across Europe’s housing market.
Projects include for-sale and for-rent properties, and range from single- and multifamily units to built-to-rent and co-living arrangements that may comprise smaller individual units with shared amenities and services. Rental unit financing may be a particularly attractive opportunity, given the demand for housing among younger people in the early stages of their working lives. Specialist subsectors, such as purpose-built student accommodation and later living for seniors, may also provide attractive investment potential.
We think the deep structural supply-demand imbalances across Europe will limit price declines for new housing—even if there’s a recession. Meanwhile, first-loss provisions that apply to developers for this kind of development lending suggest manageable credit risk for private lenders and experienced asset-based finance managers who know their way around this type of financing.
Small- and mid-sized homebuilders, meanwhile, get more extensive access to financing, which makes it easier to build housing supply in cities and towns across Europe where it’s needed most.
Private credit is playing a central role in closing the gap between Europe's high housing demand and short supply. And we think this may result in enhanced return potential for investors.
