While borrowing large sums of money to fund a development is a major financial decision and, of course, you want to ensure you’re getting a good deal, headline rates shouldn’t necessarily be your deciding factor because it’s only one piece of the overall funding puzzle.
You won’t necessarily get the headline rate
Headline interest rates can be like advertised broadband speeds: they look attractive on paper, but one rarely achieves that magic number.
The rate on the indicative term sheet you get 48 hours after your enquiry can look good. However, you then have a period of limbo where the funder reviews your project in more detail. After that, the rate often gets revised upwards, or the amount of leverage the lender is willing to provide is reduced. At this point, you may be weeks or months into the process, bumping up against a completion deadline, with insufficient time to go elsewhere.
Some lenders will also sign up a borrower at an artificially low interest rate with the intention of ratcheting it up over time by charging hefty ‘penalties’ the minute the project timeline slips by a few days.
Headline rates don’t reflect the all-in cost of capital
When it comes to development financing, you must ensure you’re comparing apples to apples. This isn’t always easy.
One lender’s rate may look cheaper, but it may only cover 65% loan-to-cost (LTC). You then have to fill the rest of your funding stack with mezzanine debt or equity, which can be expensive. There will also be legal fees, arrangement fees, exit fees and professional fees for each funder you work with. These add up quickly. Your total cost of funding may end up being greater than if you went for a slightly higher interest rate from a one-stop funding solution making up 90% of your capital stack.
Ask your prospective funders for a side-by-side comparison of what their total funding cost will be vs another financing structure you’re considering. That way, you can see what you’re actually going to make in each scenario.
- DFT roundtable: Reliable lenders, changing student demands and planning benefits in the PBSA market
- An interview with Tiger Craft: Piecing together funding from different parties can be a 'frustrating, time-consuming process' for developers
- How to get the best deal on development finance
You need to balance price and project risk
There can be an enormous opportunity cost associated with securing development financing. If you’re piecing together senior, mezzanine and equity separately, it can easily take six months before the money comes through. During those months, nothing is locked in. If things fall apart, you have to start over again.
As the clock is ticking, you’re losing time on the project. There’s also the risk that you fail to complete and lose your deposit. And that costs you a lot more than small differences in interest rate.
You also need to consider whether your lender’s interests are aligned with yours
As you know, there are always bumps in the road with property development. You have to be ready for the unexpected. And when the unexpected happens, you need a funding partner that is incentivised to support you.
If a lender is only at, say, 65–70% LTC, they’re relatively protected from issues and market fluctuations. If something goes wrong, they may, for example, be incentivised to liquidate your development — protecting their loan, but wiping out your equity.
If, on the other hand, you have a funding partner which is providing up to 90% LTC, and whose returns are linked to a successful exit, it will be much more likely to work alongside you when things go off track.
You get more long-term value from having a true funding partner
If you want to build a sustainable property development business, then you get more value from building a funding partnership than taking a pure ‘transactional’ approach. There are several reasons for this.
First, a one-stop funding solution extends so far into the capital stack that you don’t need to put as much of your own equity into each project. You can stretch your capital further to acquire more sites, so you can scale your business faster.
Second, you’re more agile. You have that funding relationship in place, so you’re not starting from scratch every time you need financing. This means you’re in a stronger position to move quickly on new projects, which gives you a competitive advantage.
Finally, you have expertise backing up your business. You have a partner to give advice, help you formulate bids, alert you to new development opportunities and introduce you to new industry contacts. Our CEO Paul Oberschneider is the perfect example of this. He built a multinational real estate empire with the backing of institutional funding partners. These funding relationships were critical because he knew they would be there to support his business and help him scale.