A lot of risk would be mitigated if independent monitoring surveyors were more experienced, claims developer

Last week, Development Finance Today hosted its first virtual roundtable, in partnership with Adair.

The topic was ‘Spotting common risks in property development and how lenders can protect themselves’.

The live event was held on 25th February, when approximately 70 viewers tuned in to watch the panel discussion.

Host Beth Fisher, editor at Medianett, was joined by Adair’s director project monitoring, Richard Payne, and associate director and head of its Midlands office, Rachel Titley.

The panel also included Andrew Evans, head of lending services at Victoria Mutual Finance Ltd; Tom Alexander, director at Aukett Swanke; Jason Green, CEO at Halsbury Homes; and Benjamin Philips, head of property lending at Alpha Property Lending. 

When talking about common risks, Benjamin highlighted that many first-time developers ‘over-spec’ their schemes, falsely thinking it will add lots of value in return. 

“While it may make it easier to sell, just because you’ve spent a pound doesn’t mean you’re going to get an extra pound back.” 

Jason noted that the experience of the developer’s management team is “lending 101” but thinks that a lot of risk can be mitigated if the independent monitoring surveyor (IMS) is as equally well skilled.  

“Most [lenders] are looking for experienced developers and yet, in the IMS world, I think we have much more of a tick-box approach,” he claimed, “and inexperienced people often come to sites to do the monitoring, and sometimes the front-end due diligence as well.”

“I see that as quite a juxtaposition — it doesn’t really make a lot of sense to me.”

He believes that cost often goes into the “variable” quality of those services but, for him, this is a false economy.   

“We all know [that] when loans go wrong, credit intensity increases massively,” he added, explaining that this means experienced people end up having to get involved and start paying real attention. 

“I would question why there isn’t that level of credit intensity throughout the monitoring phase,” he added. 

In response to an audience comment that lenders tend to confuse a developer’s high profile for competence, Benjamin agreed that someone “having a really good marketing budget and social media presence doesn’t [necessarily] make them a good developer. ”

He explained that, as a general rule, Alpha works with smaller borrowers who can evidence that they know what they’re doing, “rather than just having a lot of show”. 

Discussing how the pandemic has further increased risks during a property development project, Richard claimed that, without doubt, projects are slower than before the crisis.    

However, he stressed that some would argue that no building sites ever go as fast as first anticipated and, before Covid-19, the “weather card” would usually have been played. 

When looking at the less common risks of property development, Andrew steered the conversation to climate change.

“I think developers, historically, have not really had to think about this in large measure,” he said, with flood risk reports usually making up the extent of it.   

“Weather patterns are changing quite dramatically from year to year and areas that were unaffected are suddenly dealing with those issues today, and that can have quite a significant impact — not just on executing a development, but certainly in terms of the marketing of [it] upon completion.”

From a design perspective, Tom identified that site constraints, increased stakeholder engagement in certain cities and their surrounding areas, and the agility of designs to be able to adapt in the future should all be considered. 

“Thinking about your product and how it’s going to change is really important — the pandemic has brought that into sharp focus,” he commented.

“There’s a lot of discussion about what might happen to [offices] in the future and whether they will change. It’s quite easy to turn an office into resi, but much harder to [go the other way], for example. So, having that vision, not just for the next five years, but for the next 50 — and that’s a climatic thing as well — is really important.”

Richard expects that, in 20 years’ time, every new-build property will have a part that is modularly constructed.

“At the moment, modular building is still in its infancy,” he mentioned, clarifying that funding still proves problematic as there is nothing for the lender to take a charge over in order to pay the manufacturer.   

Tom agreed that this is where the housebuilding sector is going, as it provides “better quality” and is quicker, with some even reusing materials like containers.     

“There are risks, but climatically and with pandemics and healthy buildings, things are changing, and we need to adapt to those and, in many ways, look at new funding models.” 

When asked what the biggest risks and opportunities are for SME developers this year, Rachel said that there are arguments that construction tender prices are going down, but input costs are still rising. 

“People haven’t pressed the button on certain projects, [which] has left gaps for some contractors in their market, [allowing] developers to take advantage of that,” she stipulated. 

However, she points out that this opens developers up to financial uncertainty with those contractors. 

“While insolvencies haven’t necessarily been as high, that’s because it’s been supported by government funding — but that doesn’t mean it won’t occur over the next year [when] people [may] make cut-throat decisions to gain work  and then have to deal with the flack from that because they can’t maintain and deliver it on site.”

The full roundtable recording can be viewed below.

The audience had numerous questions for the panellists during the live event and, while some were answered within the hour, Richard and Benjamin have kindly answered some of those that we couldn’t get to:

Professional advisers such as QS’s and valuers have had an awful time trying to renew their PI cover and are having to reduce their PI cover. How are the lenders coping with this? 

“I cannot answer for the lenders but, as a consultant, I can confirm that PII cover for construction professionals has increased exponentially over the past 12 months. This is of course due to the Grenfell effect. Lenders and other clients taking reliance over PII levels from construction professionals may need to review their expectations in the real world. It is normal for a credit team to require an adviser to have PII cover for at least the size of the loan. This may need to be reviewed. Can a lender lose the full loan amount due to a negligent comment from a construction professional? It is unlikely, and maybe a level of PII of half the loan size would be sufficient in the future. However, this will need an understanding and an acceptance from panel owners and credit departments alike.” — Richard

“We are generally ok with 30%, but we find that it is sometimes possible to pay extra for higher PI. The cost is normally passed on to the borrower.”— Benjamin

What are the panel’s views on development exit facilities? 

“My personal view is that sales bridges have a place in the market, but they don’t always work well for the lender. While it is a good way to deploy capital quickly, the money may only be out for a short time (less important for IRR-driven lenders or bridging lenders). In addition, a sales bridge may be required because there is no demand for the units at the asking prices, which may mean the LTV is higher than underwritten.” — Benjamin

Richard - I note your point regarding modular construction and the reduced risk on site. However, I believe, as things stand, modular isn't yet less risky. On the modular projects I monitor (full modular housing), I find that the internal finishes are often damaged during transport to site from the factory, module placement is often delayed due to high winds, and there are issues with moisture ingress etc. I appreciate that this is informed by my own personal experience, but are you currently seeing modular projects being delivered successfully (on time, in budget and of a good quality)?

“I’m sorry you have had a bad experience. There will always need to be an element of ‘touching up’ required. Weather delays for swinging units into place is of course potentially problematic. I haven’t come across the leaks and water ingress but would suspect that is due to bad workmanship. I reiterate that modular construction is still in its infancy on a mass scale, but it will be the norm; the teething issues will be overcome. Remember, people famously said that home computers would not catch on and also that the electric car would not work! We need to embrace modular construction as the way forward which, inevitably, it will be.” — Richard

So, how do you mitigate risk to fund modular? Vesting certificates?

“Vesting certificates works when the modular units are complete and stored for delivery. The problem is that the modular manufacturers need upfront and other payments as they build the units but it is currently difficult for the lender to get a charge on an asset before it is completed. Perhaps lenders can take some form of guarantee from the modular manufacturer. I have seen real estate lenders working hand in hand with trade finance departments which may form a partnership as the modular units are constructed.”— Richard

Do you foresee an increase in PDR developments in the wake of Covid’s impact on office demand?

“PDR will be renamed and will be back and increase. There will also be PDR new-build as not all commercial buildings will lend themselves to conversion. Again, we will have people objecting to the ‘bedrooms without windows’, but these are the same people who wanted the space to be used for residential in the first place.” — Richard

“I agree that PDR is likely to continue in some form, however I think the day of the micro unit has passed, for now.” — Benjamin

What do the panellists think are the biggest/most common risks for airspace developments, and do they think this type of developments will become more popular in the near future?

“I think airspace is a fantastic way to build units in popular city centre locations where space is at a premium. The main issues are legal. As a lender, we would want a first charge over a property, but most airspace transactions need to be secured against a development agreement rather that a ‘real asset’. In addition, it requires a specific skillset to deal with the residents in the building. This is very much a growth area and, as a lender, we are trying to find a way to lend into airspace while maintaining good security.” — Benjamin

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