Dealing with developers I almost every day have a conversation where I discuss non-bank lenders, their place in the market and why you might consider them for finance. These conversations usually boil down to 3 items, Equity, Exit and Project team. I have broken these out below and then also commented briefly on cost for all those who are considering their funding for a development and wondering if a Non-Bank lender may be an option.
Per an earlier article of mine on development lending, banks typically seek 30% equity put into a development project. In simple terms this means if the total project cost (Land, Build, Civil, Prof Fees, Local Authority Fees, Contingency and Finance Costs) is $10M then a bank will lend you $7M.
I often speak to developers who have everything lined up and ready to go however have an existing loan on the development site or can’t bridge the equity gap which prevents the prospect of main bank finance. I also deal with a number who are looking to scale quickly with two or three projects and need to split their resources between those requiring greater borrowing capacity than what a bank will afford them.
Non-Bank lenders are much more flexible with this in some instances lending close to 100% of the cost of the project. Most often, however, they sit around 85% of cost which can be a significant amount more than a main bank lender. To note, those projects that are gearing up to 100% have very strong metrics elsewhere (Development Margin, Pre-sales, Project team etc.).
An equity shortfall is the most common reason I see non-bank finance companies considered for development lending and is often the difference between getting a project done or not.
The second consideration is the exit for the lender on completion. This is one of two things, either the sell down of the development or lease of the completed assets. In each situation a bank will want as much certainty as possible around the exit.
In the event that it is a develop to hold (lease) scenario then the banks preference would be for a pre-lease arrangement to be in place. This is often available for commercial property but not residential. In those situations, the method for the bank is to ensure the completed position is very conservative to provide headroom for any unforeseen changes (effectively additional contingency). This more or less translates to completed LVR’s 50% or under.
For developments that are to be sold down the bank seeks pre-sales. These are agreements in place before construction for the sale of the asset on completion. Prior to Covid 19 pre-sale cover of 1.0x was widely accepted, whereas now the banks are seeking cover up to 1.30x. The simple way to look at this is that you have to have net sales of $1.30 (after tax & coms) for every $1.0 of lending. Interestingly enough you can read that as the banks considering a reasonable likelihood of 30% of those sales falling over when it comes time to settle.
Non-bank lenders are much more flexible with the exit. They may be happy to proceed with no leases or pre-sales in place or at the very least much lower thresholds. This is particularly important in a market where asset values are rising rapidly such as 5 or so years ago. In those environments it is almost certain you will get more money if you sell your property on completion (values go up during construction). In the current environment there is some uncertainty in the market and I would encourage anyone, particularly with larger developments, to seek some level of pre-sales before beginning.
Despite that, 1.30x cover is a lot of sales to achieve off the plan and if that is unpalatable or unachievable then considering a non-bank lender may very well be an option.
Something very important to banks at the moment is a robust project team and arm’s length contracts throughout. Two key parties are the QS and Valuer, however, the most common difficulty with this is where the client is an owner developer (building the properties themselves).
This is something banks struggle with as it limits the recourse available to them in the event that something goes wrong. It is something that has become increasingly difficult to fund with banks and must be considered carefully when planning a project.
There are big advantages to this however in that an owner developer may be able to build at a much lower cost (strip out margin) than if they outsourced the project and also it can keep a team engaged through a quiet period as opposed to seeking external work.
Non-Bank lenders are open to this methodology however often taking a holistic view and managing their risk through other means if necessary. As any owner developer will tell you too, they are taking significant risk taking on those developments themselves so there is ‘skin in the game’.
Banks may also have issues with a QS or valuer (not always required with a non-bank lender) or others in your project team that a Non-bank lender will be more amenable to.
This brings us to the cost. Bank lending for development in the current market runs somewhere from 5.50 – 7% depending on the size and risk profile of the development. This is interest rate, line fee and fee. Per an earlier blog of mine, we are not seeing the full weight of the OCR cuts passed through in this space yet and I don’t expect to in the near term.
Non-Bank lenders range a little bit as there are a few in the market. The cheapest end of the market sits somewhere around 9 – 10% all up for a 12 month term. The next tier is between 11 – 13% and then there are a few that tick up towards 16%.
One thing that can be frustrating when dealing with lenders in this space is trying to figure out what they are charging you. Some offers may have an interest rate, up front fee, line fee and monthly management fee which can get very confusing. Overall though it is pretty simple to get to the bottom of it, all of the lenders will have IRR (internal rate of return) which they will be seeking. For some that will be 10% and others 13% - if you know that then you can do a pretty good job at reconciling those numbers. Most lenders too can structure their offer in whatever way suits you.
I was talking to a lender last week who mentioned they had recently completed a transaction where there was only a fee charged, nothing else (no interest or other). They then had an arrangement with the borrower that $x amount was refundable if they managed to repay the lending within certain timeframes which the borrower duly did and got 30% of the fee rebated.
The fee was large, but it was the preferred option of the borrower and gave them a very clean view of what the cost was.
Overall, although the Non-Bank lending space can be significantly more expensive than main bank finance the flexibility afforded to borrowers can truly be the gap between getting a project off the ground or not and that often unlocks a lot of value for people.
As always with lending, you do want to take some advice before going down that path. If you are considering a development or non-bank lender get in touch.