There is more funding available for short term loans right now than there are deals to fill them. There is a lot of loans transacted ‘off radar’ funded by private family money and high net worth individuals. These ‘private’ lenders do not belong to either of the industry’s trade bodies, the ASTL and AOBP and therefore will be transacting business in an unmeasured and completely unregulated environment.
Development finance is one specific part of the specialist lending sector that is growing rapidly. It is certainly one of the most risky areas of lending however and any borrower involved in developing new build properties, needs to know that they are borrowing from a lender that truly understands what is involved and truly understands the house building process – preferably with experience themselves in this area. By the same token, most lenders want to know that the developer is experienced with a proven track record and good professional CV demonstrating past projects.
There is a very big difference between taking on a light refurbishment such a new kitchen, bathroom and a lick of paint, versus developing a new build from scratch. With true property development there is more that could go wrong and the project will sometimes over-run. This is where a borrower could come unstuck if they are not with the right lender. It will be fine if everything goes to plan, but if a project over-runs then the borrower could find themselves stung with hefty fees when they need the loan for longer than expected.
Similarly, if a development project involves demolishing an existing building before the new property is built, there will be a time when the plot is likely to be worth less before any value is added. Traditional bridging lenders are more likely to work off loan to value, which works for most refurbishment projects, but does not always work for new builds. If the lender has already released funds for site acquisition and cannot release any more for the building works until the valuation is confirmed at a higher level, but the value drops before it goes up, the borrower is likely to find themselves in a position where they need to draw-down additional funds from the lender, but the value is not there to do so.
This is why even on a scheme that offers up to 100% of build costs the borrower must have their own positive cash flow to move the project along sufficiently to allow an uplift in value which allows the funder to release further funds to move the project along.
A good development finance lender will understand the process the developer is going through and as long as they are kept informed throughout, will typically be more flexible and will often consider the cost to complete a build, rather than simply loan to value lending and can even lend their expertise to assist the borrower to move the build along, especially if they do run in to problems.
Exit fees are common place in the development sector, with many lenders charging fees on the way out of a deal, as well as on the way in. With any build project, the largest uplift in value and therefore profit comes at the end when the build is finished and the property is sold for profit. It is at this time the loan is repaid and when many lenders will earn their biggest fee.
An exit fee based on the size of the loan facility, rather than one based on the GDV is certainly going to be better for the borrower, to avoid paying away a large slice of the pie on completion of their project and reducing profits significantly. Exit fees may only come in at the end of a deal, but they need to be factored in to the calculations at the start of the process. Of course a scheme that charges no exit fees or early redemption penalties is better still for the borrower, but is likely to mean a higher facility fee and monthly rate.
Property Development Finance is an exciting and growing area of the market. I expect we will see more existing lenders join this space over coming months, but it will still be some significant time before the High Street shows any real appetite in this sector and therefore once again it will be the bridging finance sector that holds the key to unlocking many frustrated borrowers’ dreams. It can yield very positive returns, but it is wise to pick your partners carefully to help ensure a positive outcome.