In this Q&A our writer, Nikhil Patel, interviewed Piragash Sivanesan from Totum Finance to discuss the topic of what lenders are looking for from a developer when considering whether to finance their next project. Totum Finance is a regulated brokerage that helps developers get funding for their project types. Totum help developers structure the deal and advise them on risk management. This Q&A took place in June 2020.
As a broker, you work with many different lenders across different development deals. How are you seeing the lending market as different today to what it was six months ago, pre-COVID?
From lenders, things have changed. How can you be sure that somebody now has the money to buy these lovely units that you’ve built, even if you do a great job? How do we know that construction can happen in the same timeframe?
It used to be that if a developer comes along and says he’s going to do it in 15 months, and then the MS also confirms he’s going to do it in 15 months, and we project manage it, chances are we’re not going to be too far away. Now, there are so many other factors. For a lender, what’s the easiest way to manage this? One option is, we’re going to step away, and we’re not going to lend for a bit until stability returns. Remember, although in the development market, in some ways, lenders do charge a higher interest than we normally used to, it’s still just a relatively low return. How much risk should they really be taking in that scenario?
The alternative option, and what we’re seeing lenders do, is to look more carefully at the deal and consider how much risk they’re taking. Before they were lending at a higher leverage, which by that I mean loan to value on a site. On a finished site, they were lending up to 70%. Maybe it’s crept down to 65%, but equally it’s a moving feast.
As a developer today, my advice is to consider working with a broker because you can really understand what’s happening with the whole market. Also, have relationships with more than just one lender. If all your eggs are in one basket, and that one basket gets smashed, you’ve got nothing to work with. It’s important that you improve the breadth of lenders that you know and work with.
Generally speaking, there’s also a big difference between how a lender might react to an existing deal versus a new deal. With a new deal, a lot of things need to be reset, whether that’s the margin, whether that’s profitability, etc. Of course, there’s also the situation where you’re stuck in a deal. If you’ve got funding in place, this is the time when you discover whether all that marketing a lender has done, saying that they’re a great lender, that they understand the market, etc. all of this gets put to the test. It’s really difficult because, for a lender, the one thing they cannot do is lose money. For you, you’re looking for a relationship and someone to work with.
As a developer, assume we’ve got a new scheme coming that we need funding for. What information do we need to provide lenders to help them make their decisions? What makes them say yes, what makes them say no, and what’s different again from pre-COVID?
The easiest way for me to explain this is to say that lazy lending is out the window. Lazy lending means that as long as the numbers roughly work, you just do the loan, keep stamping it, and try and grow your loan book, but that’s out the window.
Fundamentally a lender cannot and does not want to step in and rectify a site that’s gone wrong. A bunch of bankers running around fixing foundation levels and subcontractors that are running off site is not a pretty sight. It’s going to result in losses.
As a developer, as a project manager, as you’re first approaching this, that’s what you’ve got to have in your mind. I love to use the word ‘shock and awe’, because that’s what you got to do. You’ve got to get them into a situation where number one, it is without doubt that the project you’re putting in front of them has the right level of profitability, that it can sell. Not only can you build it, which means your team needs to have strength in depth, and then the project itself, once you’ve built, how well do you know the market?
For example, it would be crazy if you went to inner city East London and try to build a £10 million home. How well do you know that demand? If you intend to hold it, do you know what you’re doing in terms of managing it?
Then there’s little things, for example, I still want to know that when things go wrong, what sorts of sensitivities have you done? When things go wrong and the cash flow falls beneath and you need extra money, if the first and only thing you can do is turn to the bank and say, “More please?” that’s an issue. It’s not that the bank doesn’t want to support you, but the fundamentals may have changed. Do you have some sort of net worth? Do you have a set of guarantors that have some sort of net worth? This will enable the lender to say, “Okay, not only can this team build this, they’ve got a good contract structure, whether it’s construction management or a JCT D&B, the product they’re building is absolutely right for this market and we can see demand for it, but also if things go wrong, they’ve got the experience and the wealth to potentially be able to support it.” Now we’re starting to get into an arena where this feels like it’s worth helping or supporting a developer.
The final piece is probably character. This is sometimes difficult to position, but it’s about, for example, a situation where you have a person that says: “I’m going to build a £6 million scheme. Oh that’s right, I did forget to pay my direct debits for the last 12 months.” Let’s be honest, a direct debit is small, maybe inconsequential to your wealth, but it gives a mark towards the sort of person you are with regards to repaying liabilities. If you can forget direct debit on a gym membership or a mobile phone bill, how close attention are you going to pay to the covenants in a loan agreement as we’re handing you over £6 million? That’s the other piece, your character. What does it say about your past?
As a developer, we’ve found a site that works well for us. The lenders are very happy with our application. We’ve gone through this process. We’ve put together a really good team. Talk us very quickly through the process of offer to formal draw down, and again, how’s that changed?
We’re returning to more of a normal in terms of the process. A lot of that was driven by surveys and monitoring surveys, etc. What does the offer mean? The offer will often mean that everything we’ve discussed to date works. The bank likes the numbers, the bank likes what you’re saying, the bank likes who you are, and it’s the next stage.
One thing to think about before you then move forward with that is, number one, do you have more than one offer? As a broker, I would say that we always try to ensure that there are a couple of backups in there. If in this process it doesn’t work, you don’t want to then go all the way back to the start.
Also, this is the point at which there is potentially no return. Your offer is a massively abbreviated set of terms, and your full loan agreement is another set. Often, by the time you reached the full loan agreement, you’ve committed to the offer. You can’t really shift lenders. Unfortunately, you’re not in a position to be able to change terms in the loan agreement, but by not seeing it before you’ve committed to the deal, sometimes you’re not aware of certain things.
For example, sometimes in the offer, it tells what you loan amount and interest is, but it may not tell you what some of the key covenants are. It may not tell you what the level of personal guarantee is, or if a personal guarantee is required. This is something where you do really need to try and compare as much as possible apples with apples.
Then finally, think about who the lender is because there are so many new entrants coming into the market. It might be a peer-to-peer lender, it may be a private debt fund, it may be a completely private family office, etc. You need to know, because remember, this is different from just borrowing from the high street. Do you speak the same language, because the lender will often have complete power?
One thing I constantly hear is that debt is easy and equity is hard. I don’t disagree with that, but I would say that 98% of the time, it’s your debt lender that bankrupts you, not your equity provider. Who you choose is critical, especially in this market.
Then, now going on to the real meat of your question, which is what do we do? The banks approved everything; you’ve decided to move ahead with the lender. The first thing to think about is that this is really the point when you’re going to start incurring costs.
For example, valuation is something that you’re going to have to pay upfront. If it’s a sizable development, this is not going to be the same valuation as a residential mortgage. A £3 to £5 million GDV evaluation could easily cost anything from £5,000 all the way up to £10,000 because these guys will create 120-page reports. They will value your site today and what it’s worth with the planning, then they will value it when it’s finished and what they believe it will be worth and possibly some variations on that.
Then the next thing is you’re monitoring surveyor. You’ve basically said, “This is how we’re going to build it, this is who we’re going to build it with, and this is our costs and our timeframe.” A monitoring surveyor is a qualified quantity surveyor who will assess and review your costs. Sometimes, this is where developers get caught out if, for example, you’re building it at cost.
If you’re building at cost, good for you, but when the monitoring survey reviews the costs, they’re going to have to use market rate. Why is that? Because if the bank has to step in, they’re never going to build it as cheaply as you. They just need to know what that figure is and they’ll probably either increase the contingency to ensure that if they ever need to step in, the amount of the loan is enough to finish this project.
For example, let’s say you’re a small builder and you get sick and you need to then bring in another contractor to do it. They’re not going to do it at cost. That’s why you have this process.
Alongside all of this is the legal process. This is where, if you’re purchasing a site, the bank’s solicitor is going to interact with your solicitor. They’ll want to know all the information about purchasing, what’s happening with the title, what’s happening with the planning, etc. It’s in the details; sometimes you think you’ve got full planning, but actually, there’s a couple of big points outstanding that you haven’t solved. Unless you’ve solved that, it potentially becomes an issue for the bank.
Alternatively, maybe you have planning but, for example, your access to the site is a bit unusual. Instead of freehold access, you have to use a right of way and it has not been mentioned to date. Suddenly everyone thinks, “If that was ever refused, what’s the value of the site now?” A lender has to think that way, so the legal process is important. In some ways, it protects you. If you have a great solicitor, they should bring up a lot of these things beforehand.
Part of that is just the physical purchase. Then the second part is to do with the loan agreement and the security documents. We’re going to get a loan. What does the loan agreement look like? What are the security documents? Are we just talking about a simple charge on the land? Are we talking about guarantees? Board minutes to ensure that all of that is being conducted in the right way. Are you giving a personal guarantee, etc.? There’s a whole list of elements, and it sounds a lot, but of course you will have a solicitor. You’re not doing this yourself. You will have a solicitor interacting with the lender’s solicitor in order to complete this.
Then finally, there’s the construction documents. This is where it’s really important that your solicitor fully understands construction, because if you’ve got a solicitor and they typically deal with conveyancing, they’re obviously good at what they do, but construction is another area, it’s another specialism. Ideally, you use somebody that’s already au fait with all of that because there’ll be things like collateral warranties to deal with, indemnities, understanding all the different JCT contracts, making sure the appointment letters are all done in the right way, etc. The reason why the bank needs all of this is because they themselves may have to step into this contract at some point.
Now, how do you keep a note of this? When your loan agreement is issued, there’s something called a condition precedence list. These are all the things that you must do prior to drawing down. You cannot draw down unless they waive it. What I love about that is that is your checklist. That’s your checklist to check in with a solicitor, to check in with all stakeholders, to see what is it that’s on there, what’s problematic.
Then finally, just to be aware, some banks will charge a commitment fee at this offer stage. You need to be aware that you may have to put your hand in your own pocket. It varies, but typically they charge between 15% and 100% of the arrangement fee (the loan). Because of that, it means you may have to fund it up front; often it will be deducted when the actual loan comes in so you’ll get the money back or you’ll get more money on net day one.
That’s something to be aware of because sometimes it can come as a nasty surprise. Why do banks do this? It’s not because they’re greedy. It’s because sometimes people can waste their time with deals. They’re now going through a more detailed process. If you’ve got three banks running the same process at the same time, and you choose one and you say, “Bye-bye,” it’s a lot of management time.
The other thing you got to be careful is while a lot of them have refund policies, you’ve got to read the terms carefully.
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