The ability to assess lenders correctly is arguably the most important ingredient if you are going to select the right option for your development.
There are two key areas. Firstly, understanding where the High Street Banks are now, and how they compare to the ever-growing list of specialist development finance lenders. Secondly, understanding a lender’s entire criteria, and in particular ensuring you go deep enough into certain parts, which is where the interesting info lies that will save you or cost you thousands.
1.The Difference between the Banks & Specialist Lenders
Since 2008, the appetite of the High Street Banks has changed dramatically. Government directives for banks to hold more cash reserves have meant that certain sectors have lost appeal. One of those sectors is development.
The High Street still lends, and technically is still as cheap as any other lender, if not slightly better.
However, they struggle with 4 main areas: speed, leverage, deposits required and cross-collateralising.
The High Street is notoriously slow at making decisions and getting loans out. Where developers have to act quickly to take advantage of opportunities, the High Street’s processes are unable to match that speed.
Specialist development finance lenders tend to be leaner companies, who are able to visit sites quickly, and assess applications just as quickly with often daily Credit meetings.
The High Street's main disadvantage is the lack of leverage. Most of them will loan around 50-55% of GDV gross. When fees and interest are deducted, the net advance is often around 45% of GDV. In an era of high land prices, rising build costs and squeezed margins, developers simply can’t raise enough money from banks without raising more from expensive avenues like mezzanine lenders.
Development finance lenders tend to be better leveraged at up to 75% of GDV, although most are in the 60-70% range gross. This means developers are far more likely to raise all of the funds they need from one source.
Deposits required (for site purchases)
The High Street needs a lot of money going in on Day 1 for site purchases because their Loan to Cost ratios are much lower (typically 70-75%). Development finance lenders have higher ratios (typically 85-90%), meaning a developer is not tying up so much capital in each project, and can potentially invest in 2 or 3 more sites as a result.
Whilst the interest rate might be slightly less with the High Street, if the developer goes with the High Street, he is likely to miss out on other opportunities, or they will need to be funded with expensive JV partners. In the end, the slightly cheaper interest rate is more than off set by the profit given to a JV partner, or the lost profit missed because other sites could not be bought due to lack of capital.
It is common that the High Street will not fund the second project once the first has sufficient equity to do so. Development finance lenders are more agile in this respect, and can look across multiple projects should the numbers work.
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2. Understand lender’s criteria at a deep level
If you are going to truly compare the lenders you come across, there are a number of areas to consider.
Below is a checklist of 23 questions to ask:
1. What is their min/max lend?
2. What Geography do they cover?
3. What is their maximum Loan to GDV %?
4. What is the maximum Loan to Project Cost %?
5. What is their typical interest rate?
6. How do they apply that interest rate to the loan
(e.g. to the drawn balance, the facility as a whole or based on IRR projections?)
7. If interest is charged on the drawn balance, is it applied using a cumulative balance model or an S Curve cash flow model?
8. What is the minimum interest period?
9. Do you retain interest or take it out of sales at the end?
10. Is the interest compounding or non-compounding?
11.What assumptions do they make when stating the amount of interest you will pay?
12. Can they show you a breakdown of the monthly interest via a cashflow model?
13. Is the arrangement fee calculated on the gross loan or the net loan?
14. Do you have to pay any of the arrangement fee upon credit approval?
15. If so, is that refunded if the deal doesn’t go ahead?
16. Is the exit fee calculated on the gross loan, net loan or the GDV?
17. What security do you need? (usually 1st charge and debenture)
18. How are they funded?
19. What will happen if you breach their covenants? i.e. will they fund you more or will they expect you to put in more cash?
20. You have to pay contractors on time – what happens if drawdown is late?
21. On what basis would they pull the loan?
22. Who is on their panel of valuers?
23. Will they cross-collateralise if you have a second project, and you have sufficient equity/sales in on the first project?
Chris Davidson is Managing Director of Discover & Invest Ltd, a specialist development finance brokerage and operator of the Discover Development Finance website.
Chris believes in providing property developers with groundbreaking insights into the marketplace, that will allow developers to make better informed finance decisions, quickly, painlessly and cost effectively.
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