We are undoubtably living through times of exceptional economic uncertainty and financial volatility, the consequences of which are being felt most severely by many in the housing market. As 2023 gets underway, we discuss the five things you need to be thinking about when trying to secure development finance this year.
Building Cost Contingencies
Development Exit Strategy
Net Asset Position
Loan Term Extensions
1. Building Cost Contingencies
If there’s one thing we’ve learnt over the past two years, it is to expect the unexpected. In the context of a residential development scheme, even though a great deal of thought, planning and experience goes into each project, we still regularly come across unexpected items, most often either at the start of the project or at the very end. Most common unexpected items that come up are things like:
Unsuitable ground conditions due to things like contaminated earth, sewers, concrete, slab
Unsuitable service connections such as drainage
Sharp increase in the price of items that go in last such as kitchens and bathrooms
As such, we typically advise developers to set aside a 10% contingency of total build costs to mitigate any unforeseen circumstances, even though this could be broken down to 15% contingency in the feasibility stage, 10% during the elemental cost planning stage (getting quotes in) and 5% on award of the contract. As lenders, we want assurances that the developer will be able to deal with any of the unexpected items listed above. The building cost contingency serves exactly that function.
Additionally, on large projects, contractors may offer what is called a 'performance bond' which acts as a guarantee from the construction companies undertaking the development project.
2. Development Exit Strategy
Assessing the exit strategy on a scheme is becoming increasingly important, even more so in the current market environment. To highlight the importance of the exit, having a poor exit strategy was the second most frequent reason why we at Blend rejected a scheme over the past 12 months.
What, then, is the typical exit strategy? Well, quite simply, it is either to sell or to keep and refinance into a buy-to-let mortgage – in turn, the selling may include selling into the open market or selling into housing associations and councils. There are many reasons why a borrower would want to keep and refinance. It may be that it is not the right time to sell, something we’ve increasingly seen over the past few months, or more likely, that it was never the borrower’s intention to sell. In any case, it is very important that the borrower knows at the outset what the exit strategy will be and plans for it. For example, if the intention is to keep, it is important that the borrower knows that they are going to qualify for the long-term loan and gets a Decision in Principle (DIP) from a mortgage lender. This acceptance only lasts for about six months, but it gives us, the lender, the comfort that the borrower will be eligible for a mortgage at some point in the future and also that he has been organised and forward thinking enough to make an application. When the scheme is completed, the borrower can invoke his DIP, or re-apply if it has expired, to get a mortgage that will be used to repay our development loan. But really, at the end of the day, it all boils down to us, the lender, being comfortable with the valuation when the project is completed, or the Gross Development Value.
3. Net Asset Position
Establishing the net asset position for borrowers is becoming increasingly important. In any market environments, but more so in the current market environment, cash is king and lenders like us will assess the borrower’s liquidity in order to mitigate any time delays, cost overruns, or slow sales.
As such, we always advise developers to spend enough time ensuring they are able to demonstrate strong finances that will allow them to solve any challenges. That will allow them to be in a better position to secure development finance at a more competitive rate.
4. Loan Term Extensions
A pandemic, supply chain disruptions and labour shortages against a backdrop of weak economic growth mean that over the past couple of years, development schemes have faced severe delays and increased time pressure to achieve sales. As a result, many lenders have had to rummage through their lending terms to approve loan term extensions to mitigate the risk of default by the borrower. Here at Blend, we’ve always had a 6-months loan extension automatically built into our development loans, even prior to the current market challenges. That’s because we understand that in property development, it is not about ‘if a challenge comes up’, it is about ‘when the unexpected happens’. That’s why we stand ready to support our borrowers through the tough times and the great times.
Understandably, developers will not always be comfortable with higher loan terms due to the higher interest costs as many lenders treat the loan term extension as a default and apply exorbitant penalty fees. Not so at Blend where our built-in 6-months loan extension comes with the same terms and the same interest rate agreed on the outset for the entire lending facility. No penalties, no sticks. Just alleviating the stress off of our borrowers and supporting them through the tough times.
The market prior to last September’s ‘Mini Budget’ debacle was generally offering leverage at 60-65% LTGDV. Then, liquidity drained significantly overnight due to the confidence in the market in the aftermath of the UK financial meltdown. The market has now started to re-open and here at Blend we have now pushed our leverage further up to 70%. Borrowers should expect to obtain 65-70% with the right schemes currently, while we can increase the LTGDV to 75% if additional security is provided.
Whatever you are up to in 2023, we are here to support you with your development schemes. Whether you've heard of us but we’ve never spoken with you and you’re exploring your options, or whether you’re feeling positive that now’s the right time to proceed with a project and want to ensure you have the capital to opportunistically do this, feel free to get in touch and we’ll see if we can help. And always remember, your interests as a developer and our interests as a lender run in parallel and are virtually the same. You do not want your project to fail and neither do we because it puts the loan at risk. So, that means that sometimes we will need to have tough conversations and ask difficult questions, but that is only because they are prudent questions usually borne out of the greater experience of projects that we will have.
The Blend Team.
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