How Secure Are Development Lenders' Terms?
It has become increasing noticeable over the last few months that a combination of falling confirmed GDVs at valuation report stage and an increase in required project costs at QS report stage are causing developers a major headache with cashflow.
These cashflow problems can best be understood through the lens of both the application process and the marketplace.
How the Process Adds Risk
The problem with the application process is that the valuation and QS reports are actioned after lenders have issued terms, which have been based on previously provided project figures (i.e. projected project Costs and anticipated GDV).
Lenders effectively issue terms ‘blind’, meaning they do so without having the confirmation of value and project costs back in. All terms, with any lender, are subject to these reports backing up the original figures.
In a strong, or stable market, when GDVs and project costs are stable, lenders’ terms also remain stable. As a result, one can assume correctly what level of cash needs to go in on acquisition, and can be confident of those projections from the outset.
In an uncertain, variable marketplace, however, if either the GDV goes down, or the project costs go up (or worse both), this can potentially leave both lender and developer with a cash problem to solve right at the end of the application process.
Lending Consequences of GDV/Cost Changes
If the reports vary from the initial projections on costs and GDV, the lender usually has to make some adjustments to their terms.
If the GDV goes down after valuaiton, the lender is lending less (if they maintain the same Loan to GDV %). The result is a cash gap that the developer may have to fill (if there is no room left in the facility to increase funding).
If the project costs go up at QS report stage, this means the lender requires the developer to borrow more money, and forces the gross loan facility to increase in line. Either the cost of borrowing goes up or, in the worst case again, the developer may need to fill a cash gap with more capital required from them to go in.
If you have both of the above, it can be an unpleasant, negative double whammy on funds in.
Why leverage is key to mitigation
The key aspect here is leverage. If there is room available in the lender’s Maximum Loan to GDV % parameters, then the lender can potentially cover the extra costs by increasing the facility.
So if your original loan was at gross 60% of GDV, and the lender can go up to 70% of GDV, there is room for manoeuvre if valuations or QS reports cause problems with the numbers.
If, however, the original projected loan is close to the maximum Loan to GDV % of your lender’s criteria, then it can often take only minimal negative changes in GDV or Project Costs to result in the borrower being required to put more money in. The larger the change, the more funds you may have to put in.
What are the solutions?
Again this is becoming more and more common, and there are different ways to mitigate any changes if you can.
1. You could change the process around to your benefit by getting the valuation and QS reports done before you go to get terms from a lender.
This way everyone has total certainty before terms are issued. One could argue these are upfront costs anyway, and if you have some site purchase security then it's less of a punt. Just ensure that who you use for these reports are on your lender’s panel.
2. If you’ve already got the reports back and they have had an impact on the terms provided, there is always room for negotiation; some valuers and surveyors may move a little on their numbers and that can be helpful.
3. In terms of preparing for future projects, you could safeguard yourself by using lenders with the maximum leverage in the marketplace; they will be a little more expensive and you might not need the extra room they provide in the end, but it gives you space in case the valuation or QS reports go against you.
4. If this current uncertain marketplace continues, as it is bound to do until the end of October at least, it is wise going forward that plans are made for putting in more cash than you think you will need, just in case again the Val/QS report results go against you.
How secure then are lenders’ terms?
In answer to the original question, lenders’ terms are only as secure as the marketplace we’re operating in, given the usual process of getting the reports done after a lender has issued terms.
Lenders’ terms are always subject to the valuation report, QS report, and the legals, all of which can affect the original projections and expectations. If the marketplace becomes uncertain, surveyors tend to be more conservtive, resulting in lower GDVs, higher antincipated project costs, and potentially a capital gap to fill that the lender cannot help with.
In the end, lenders 'hang their hat' on the result of valuations and QS reports. Ultimately, if an uncertain market market continues, it becomes more prudent than ever to prepare well financially and build in provisions for worst case scenarios at valuation and QS report stage, if you don’t decide to get the reports done first before lenders issue terms.
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