Comparing Lender Term Sheets
If you’ve been comparing lender term sheets for any length of time, you will notice there is no uniform practice employed across the lending community. As a result one of the unfortunate facts of the development finance marketplace is as the borrower you are rarely comparing ‘apples with apples’.
The knock-on effect it is really easy to select a more expensive lender, and cost yourself thousands in the process.
Why is it so difficult in a little more detail?
Simply lenders do not always include the same set of costs in their offer, they use different methods to calculate the costs, and some do not use your cash flow projections to boot when doing so.
The three main issues are as follows:
1. No standard practice for assessing all costs
There are many examples, but some of the more common ones are:
- Some lenders don’t include exit fees in the total costs, stating they are technically outside the loan. This needs to be factored in.
- Some lenders cover QS and/or legal costs in the loan, some don’t and need to be factored in.
- Some lenders require a % of the arrangement fee to be paid upfront, some don’t.
- Some lenders retain interest and pay back what isn’t used pro-rata, some lenders take interest at the end out of sales
2. Not comparing interest, nor the interest rate, at a deep enough level
Is the rate calculated on the drawn balance or the facility, or a private equity based IRR model? Is the interest compounding, non-compounding?
If lenders are using different models to calculate interest, the borrower needs to be very careful that they do not miss out of lenders who appear expensive that aren’t, and vice versa.
3. Assuming the terms are based on one constant
Often competing lenders are using different cash flow projections to come up with their interest projections. Whilst every lender will say “it’s only a projection”, it doesn’t help the developer who is trying to compare competing term sheets if there is no constant.
Have the lenders used your cash flow or their projections of your cash flow requirements (which are often very different)? Getting this wrong can make the projected interest unrealistically low or high, and can unintentionally affect the borrower’s decision making.
The only way to find this out is to make sure every lender is putting in your likely cashflow projections, and providing you with their calculation model as evidence. You may be surprised to see how much the interest projection changes, for good or bad!
In summary then, the development finance marketplace continues to be a minefield to explore, understand, and ultimately ensure you’re choosing the right finance partners.
If you would like help comparing term sheets, or the funding process in general, sign up for our ‘Slash 50% off you Finance Costs’ Report, and we will pass on our marketplace knowledge to accelerate your learning.
Chris Davidson is Managing Director of Discover & Invest Ltd, a specialist development finance brokerage and operator of the Discover Development Finance website.
For UK Property Developers needing £500k to £20m