John McNamara

What developers can do to prevent problem lending cases



There are several factors that can cause an increase in problem development lending cases.

These are outlined below, but the first port of call is the development appraisal and the development appraisal due diligence of the project to see if it works in terms of cost and profit.

The main issue in the fall in development finance applications can be eradicated with the initial due diligence of the scheme.

The developer/client needs to understand the project feasibility, cost, timeline and profitability.

The simple solution to this is to carry out a detailed development appraisal of the scheme and follow this up with due diligence so that every sale/cost and revenue is correct.

The appraisal should include:

  • GDV sales of the units – check comparable sales prices £sq ft/£m2
  • any freehold sale – this should be ideally factored in due to new legislation
  • purchase costs
  • build costs – check comparable sales prices £sq ft/£m2 and build costs in the area
  • build cost contingency – at least 5% of the build cost, ideally 10%
  • all professional fees – QS/architects
  • warranties/insurance
  • professional fees
  • professional reports – valuation, site investigation
  • finance costs
  • marketing fees
  • any other costs
  • legal fees both for purchase and sales

Once this appraisal has been completed and the due diligence has the comparable evidence to be realistically achievable, the appraisal should also consider at least a 5% contingency, ideally reaching 10%, to cover any surprising overspends and cost overruns in the project construction delivery.

This is often not included – or if it is, it’s at a very low level – in the development appraisals we see from developers.

Once this development appraisal has been completed, this will then give the qualifying number to see if the scheme is feasible in terms of cost and profitability.

The main factor would be the profit, which should be no less than 20% of the GDV.

This will also advise the loan-to-cost (LTC) of the scheme – the ceiling on this qualifying factor is 90% LTC.

The loan-to-GDV (LTGDV) ceiling in the development finance market is 75% LTDGV.

This will also give the residual value of the scheme (RVL).

Could the rise in problem development lending cases be due to inexperienced market entrants?

Recent enquiries and applications to Focus Commercial from inexperienced, potential developers show that they want to purchase and develop these construction schemes either by refurbishment or new ground-up developments.

Here are a couple of examples of inexperienced or first-time developers either not incorporating a development appraisal and due diligence (example one) and incorporating a development appraisal and due diligence – the client called this his site analysis – in the second example.

Example one

Recently we had an enquiry from a potential developer who wanted to obtain the funding to purchase a site without conducting a development appraisal and due diligence of the scheme.

When we appraised the project ourselves, the figures for the scheme they intended to purchase and develop had a development profit of 3.26% (the minimum standard for a scheme is 20%).

The client also wanted to have full development finance without the initial development appraisal due diligence and the supporting documentation of all the factors in the scheme.

We advised the client not to proceed with the scheme as after our detailed analysis, the scheme did not work in terms of profitability and cost.

Outcome

This saved the client money, time and heartache.

Example two

We had another inexperienced, new developer who approached us, but who had done an initial site analysis of the scheme.

We looked at his site analysis figures and checked the figures with our own due diligence and entered this into our own development appraisal and educated the client in what was missing in terms of costs and contingency.

The client listened to our advice and with the development appraisal and due diligence completed on the costs and profitability of the scheme, we were able to package and submit this to an experienced development finance lender.

Outcome

Along with other factors (such as due diligence stakeholder engagement) consider:

  • profitability, scheme loan requirements to fit market/lender’s appetite LTV/LTC/LTGDV
  • security and location due diligence
  • developer exit routes – end sale diligence and refinancing criteria to suit end of scheme
  • understanding the construction cost analysis and process
  • building a professional team
  • construction build-out to tender with JCT/own sub-contractors

Result

The client is about to drawdown a development loan facility of £5.7m.


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