A recent NZ Herald article referenced the difficulty in the property finance market at the moment. It is true that recently, in response to Covid 19 and the national shutdown, a number of lenders withdrew from the market. There is some market rumour that this was driven by the withdrawal of funding lines for non-bank lenders which is not entirely the truth. In reality this was a natural response to the uncertainty and inactivity in the market.
What I can confirm however is that the reins have been loosened over the last 4 weeks and there are a number of lenders (including banks) who are back in the market. I currently have funding offers (put to market over the last 4 weeks) on 3 different projects of varying sizes. I am also regularly fielding calls from various lenders about what we are seeing and what opportunity we might have to share with them.
I acknowledge that the criteria on lending is certainly tighter than it has been previously, but it is available. What we are seeing is a shift down the risk curve across the full lending market. I have three key tips to developers looking for finance are below.
Loan to Cost Ratio
This is the ratio of the level of debt you are taking on to complete your development vs the amount of equity that you are putting into the development. It is simply calculated as the total debt / total cost (including land & finance). Previously banks were keen to push this out to 75% on good projects (meaning on a development that cost you $10M you would be able to fund say $7.5M) but more often than not their target was 70%. Non-bank lenders would push out to 85 – 90% (in some cases higher) if the project had enough merit.
We are now seeing banks cap out at 70% (in some cases looking at say 65%) and the non-bank sector dropping to 70 – 80% of cost.
Exit on completion
This can be broken down into two areas, Pre-sales (if you are selling down) or Income on completion / Pre-leasing if you are holding the asset. This is where the majority of developments fell down with main banks pre-covid 19 and the primary driver to non-bank lending.
Firstly, Pre-sales. It is the ratio of net sale revenue to total debt and manages the exit risk of a development as well as serving as market acceptance of the product and price. Banks previously sought this to be 100% (i.e. if you were borrowing $7.50M for a development the bank would want pre-sales totalling $7.50M). Non-bank financiers would proceed often without any pre-sales allowing developments to get underway and be sold down on completion or throughout the project.
In the current environment banks are pushing that pre-sale cover to 110 – 130% of debt. This is a result of perceived settlement risk of the pre-sales. Non-banks are now looking at some level of pre-sale cover, often not 100% (and sometimes none at all) but something to manage the exit risk.
Secondly, income on completion / pre-leases. This is where the lender assesses the income expected on the asset (by way of pre-agreed leases or expected rental) on completion. A bank historically would seek say 1.50x interest cover on residential assets and 2.0x interest cover on commercial assets. This is simply the Net Income / Actual Interest Cost. Banks are now looking at a cover of 1.75 – 2.0x on residential assets and 2.0 – 2.5x on commercial assets and will require leases to be signed pre-development.
What is curious here is that the Non-Bank sector isn’t far removed from these numbers. The reason for this is that Non-Bank lenders often do not offer long term hold facilities for product and therefore require a refinance on completion for their exit. This needs to be on a banks terms.
Some non-banks however will look at underwrites or short-term warehousing facilities whilst a property is being tenanted / trading up on completion.
Project team & experience
This is increasingly becoming a focus of all lenders and something we saw more of pre-covid 19, particularly from the banks. Lenders are looking at the experience of the developer and the team that is on the project as to their capacity to deliver the project on time and to budget.
This is where sometimes paying more is really worth it. Builders are being increasingly scrutinised by lenders as to their capacity and ability. Banks will now often, on large projects, seek some assurance around the financial stability of the head contractor (this is something that was seen post Mainzeal and Eberts). When going to market, do you due diligence and ensure you are engaging with the right parties.
Outside of the builder there are other areas that will add strength and credence to your development. Work with a good QS, this is a really key role in a lot of developments and something in those of a larger scale worth engaging early. A QS will be able to give you a good steer on price, help negotiate key contracts and put the lender at ease. Often on larger projects we see the QS engaged with the tender process for the build contract managing that for the developer.
Project Management is another key aspect of any lending proposal. This helps mitigate any pitfalls in experience of the developer and is something that not only adds value to the lender but the developer as well. Having an independent Project Manager on your development will ensure that they continue to hold the key parties and contractors accountable and to their obligations. A number of professional firms will offer both services (QS and PM work) and can be a great solution or there are other independents in the market.
So a couple tips there for anyone looking to develop at the moment. The important thing to remember is that there is still capital available for projects providing the risk profile is OK and often this is in no way insurmountable.
I also expect, from my conversations, to see the lending markets continue to loosen up over the next 2 months. As commented above, we are seeing a full shift down the risk curve from all lenders with most Non-Bank players towards the channel the banks used to occupy.
If you have a project in the pipeline sing out, we have access to the full market and specialise in working with clients to get projects to a point where funders will happily lend. We can introduce you to and bring in experts required, in some instances help with leases / financing end buyers and most importantly speak regularly with all lenders engaging with them on many projects.
Don’t believe the hype – the world continues to turn.