Development Finance Market Review Q2 2018
In our new, regular, quarterly bulletin on all things development finance, we provide our readers with a real time update on marketplace trends, so that you know what’s really going on and how best to tackle this ever expanding marketplace.
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Most developers and associates understand how important this info is in order to make the right decisions quickly.
With over 40 senior debt lending options, 20 mezzanine options and a small but increasing number of equity and JV options, the choice has never been greater. But with more choice, comes more confusion in selecting the right lender/funding for your projects.
Not only that, but lender products also change regularly. Around 25% of lenders change some part of their policy every 3 months, so it literally ‘pays’ to stay on top of what is going on!
Below we will breakdown the different variables, and see what changes may be occurring that you need to know about. We will then take a look at current trends and provide general market sentiment. By reading this, you will be able to go away armed with up to date information from industry insiders that will help you make better funding decisions.
There has been a noticeable increasing of liquidity in the marketplace generally. It has been noticeable in the last 6 months or so that maximum loan amounts have increased substantially and there is a general appetite to lend more volume where possible.
3. Geographical Appetite
This is one of the biggest changes in recent times. Many lenders who remained focused on London and the South East have found that deals often struggle to “stack up”. This is due to sky-high asking prices, rising construction costs, reduced GDVs, and ultimately greatly reduced margins, as developers will be well aware.
With cash squeezed, many developers are struggling to come up with the cash deposits required, and so lenders, with increased liquidity, have to look further afield in order to lend funds.
Several lenders have opened new offices in cities in the North of England, and are looking further afield into Scotland and Northern Ireland as well. This trend is likely to continue as locations previously sunned by lenders are given more consideration, resulting in other lenders following suit into those said areas.
4. Headline Interest Rates
As a result of increased liquidity, competition, and a continuing base rate hold, headline interest rates have been reducing across the board. Interestingly, some mid market lenders now offer much lower rates for lower ‘Loan to GDV’ requirements on a staggered basis i.e. 10% still for 70% of GDV, but as low as 6% for 55% of GDV. Therefore, at the very cheaper end, there are several new options than there were 6 to 12 months ago.
Remember interest rates are not a great way to compare your interest costs anymore. This is because lenders can use one of three different ways to apply the interest rate and therefore how they calculate their interest. As a result, lenders with same interest rate can be charging different amounts of interest! Always ask how the interest portion has been calculated, and preferably understand how it has been cash-flowed. You may be surprised by what you find and which lender comes out cheaper!
5. 'Loan to GDV' Thresholds
With the uncertainty over Brexit and the global economic picture in general, lenders are becoming a little more conservative on GDVs, and therefore how much they can lend.
Whilst this isn’t the case with every lender, leverage is reducing in some quarters by around 5%. So whereas 3 to 6 months ago, a lender might have been at 70% of GDV, they are at 65%, and if 65%, they might now be down at 60% of GDV. The knock-on effect will be the need for larger deposits, as we will discuss.
6. 'Loan to Cost' Thresholds
As a result of lenders lending a little less in general against the GDV, they are also looking to lend a little less against the Total Project Costs.
Again a 5% downward trend is in play, but there are still several lenders who will look at 90% Loan to Total Project Cost (which is a figure that typically excludes finance and disposal costs).
7. Cash/Deposits Needed
As a result of Loan to Project Cost/Funding Requirement ratios reducing, borrowers will increasingly have to come up with more of their own funds. An increased injection from the borrower of around 5% to 10% of the total project costs is, and will become, fairly typical. The consequences across multiple projects for some developers might be the need for an injection of equity investment if they don’t have the extra cash.
8. Arrangement & Exit Fees
Arrangement fees very much remain the same at 1% to 2%, but how they are applied can vary, which can be against the net loan or the gross loan. Always worth double-checking!
Exit fees still vary widely from zero to a % of GDV. The exit fee structure tends to differ between those lenders who are backed by debt lines and those who are back by private equity lines, with the PE lines requiring higher overall returns. Lenders are conscious of the difference it can make, so there can been a softening on some offers, from 2% to 1%, or from a % of GDV to a % of the loan i.e. from a unpredictable variable cost to a fixed cost.
9. Change in Marketplace Appetite
Lenders, regardless of price and volume range, are all increasingly moving towards wanting to fund the very same type of scheme, which is the most low risk in their opinion.
The low risk schemes we are talking about are the ones that are likely to have the highest demand i.e. the most buyers. These are properties priced up to the £700k to £800k mark. Higher risk sectors such as prime luxury have far fewer buyers and are therefore less desirable to lend on, particularly with the changes at the top end.
Otherwise, along with the need for borrowers to put in a little more cash, some lenders are looking for higher project margins to be on the safe side. Minimum project margins for lending approval have typically been 20%, but some lenders would like to see nearer 25%. Anything over 25% is of course a bonus.
10. New 'Quick Build' Technologies
The newer technologies are in theory a developer’s dream for improving project profits dramatically. If you’re unfamiliar, it is down to the fact the build period is much quicker, and therefore most project costs across the board are greatly reduced as a result.
Whilst the options in the marketplace continue to accelerate, it comes with a cautionary note regarding the ability to finance effectively.
Quick build technologies need a larger input of funding from lenders much earlier than for traditional builds, due to the very nature of the speed of delivery. We have, however, seen evidence of surveyors not being able to provide enhanced value early enough in order to cover off the cash spent on site.
This can put some developers in cash flow negative positions, or in the worst case, unable to complete on orders for site. Always double check your cash flow projections with your lenders, and ensure they are going to be able to lend when it comes to the crunch. Some cannot!
We will update this sector regularly, as the benefits to developers are compelling, alongside the increasing need for valuers and lenders to work in a more efficient manner with the borrower.
11. Prime/Luxury Market
There are now more than considerable lending restrictions in this segment at the moment. By Prime/Luxury, we mean from £1m upwards, or £1,000 per square foot.
Starting in London, the issue has been that sales of prime property have fallen dramatically, due to a lack of incentives brought in to restrict overseas and top end buyers. As a result, virtually all lenders will decline enquiries unless there are pre-sales in place or an equally valid and de-risked reason for lending given.
If you are looking to develop at the luxury end, ensure you have researched the marketplace thoroughly, and are sure funding for your project is available. You may need a private investment source in order to deliver on the project, or pre-sell to a buyer who will effectively fund your build “off-plan”.
12. Joint Venture Finance
The 100% JV funding market is beginning to expand as well, which will be a relief to many developers with funds tied up in current projects, or simply lacking the resources to complete on a solid project.
On top of a couple of mainstream options, three other structured funding options have entered the market on a private basis, so competition is increasing. This should begin to drive down profit share arrangements, which are anywhere from 50-50 up to 70% in favour of the lender.
13. Development Exit Finance
A growing number of lenders are now offering this product in light of the current marketplace. With schemes complete and sales slow, having to extend facilities with lenders can be a worrying development that you had not bargained for. Not only is the slowdown in sales eating into your margin with every passing day, but also there is the worry that one day the lender may require you to service the interest and some of the capital. Clearly this is not possible for many developers with funds tied up in projects.
Finding a lender who will take over the loan on a rolled interest basis can take the pressure off situation, provided the costs of changing lender are equal to, if not better than, the current facility in place.
As uncertainty over sales continues, we expect this to be a product with increasing levels of demand from developers.
14. Summary and Sentiment
So the general situation as of the end of Q1 2018 is that we have an expanding marketplace, with options continuing to grow. We also have lenders with significantly more money than before coupled with cheaper interest rates.
A caveat to this, however, is that they have a slightly more conservative outlook on how much they will lend against the GDV and the Total Project Costs. The result being developers/borrowers will have to come up with a larger deposit, if the site is being purchased. Return on equity is therefore going to be smaller, and with increasing cash flow demands on multiple projects, more and more developers are seeking, or likely to seek, further equity investment in order to get future projects off the ground.
The marketplace is certainly changing, and in the last 3 months we have seen 50% of the top 50 lenders change some part of their offering or criteria.
If you would like to stay abreast of the marketplace in 'real time’, you can do so for free by accessing our Quarterly Lender Comparison Data by filling in the form below.
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For UK Property Developers needing £500k to £20m