A Banker’s perspective. A Broker’s view
The building work is finished. But is the Development Finance still doing its’ job?
There's a point in almost every property development when the focus changes.
After months, and sometimes years, of planning, negotiating, building and dealing with the seemingly endless challenges that accompany a development project, the properties are finally finished.
The contractors have moved on, building control has hopefully signed everything off, and the estate agents are busy reassuring everyone that there's plenty of interest.
And why wouldn't they? Optimism is practically part of the job description!
The developer can, at last, turn their attention to selling the properties and realising the profit from all that hard work.
But there's something I've always thought deserves more attention at this stage.
If the nature of the development has fundamentally changed, shouldn't the financing arrangements be reviewed as well?
The risks have changed. Has the finance?
Having spent over 40 years involved in property finance, first as a banker and latterly as a broker, I've had the opportunity to see development lending from several different perspectives.
One thing that hasn't changed is the fundamental relationship between risk and the cost of borrowing.
Development finance is priced to reflect the risks associated with construction. Those risks are very real, and lenders are quite right to take them seriously.
But once a development is completed, many of those risks have disappeared.
The lender is no longer funding a construction programme, worrying about cost overruns or monitoring whether the next stage of building work will be completed.
Instead, the security comprises finished properties awaiting sale.
Of course, risk hasn't disappeared altogether. Sales can take longer than anticipated, valuations can change and property markets don't always behave as we'd like.
But it's a different risk profile.
And that raises a perfectly reasonable question.
Is a development finance facility still the most appropriate way to fund a completed development?
The cost of waiting
Let's consider a fairly typical situation.
A developer has completed a residential scheme with a gross development value of £5 million.
There's £2.5 million outstanding on the development finance facility, and the properties are being marketed.
The developer is comfortable with the asking prices and doesn't particularly want to start offering discounts simply to accelerate sales.
Quite right too.
However, the original development facility is still running, perhaps at an illustrative interest rate of 1% per month.
That's £25,000 a month in interest, assuming the full balance remains outstanding.
If sales take another four months, the interest alone could amount to £100,000.
Now, I'm not suggesting those figures are unusual or that the original lender is charging too much. Development finance has a particular purpose and is priced accordingly.
But I would suggest that £100,000 is a sufficiently large number to justify asking whether there might be a better alternative.
And that's before considering any extension fees or changes to the interest rate as the facility approaches maturity.
Of course, even the most enthusiastic estate agent can't dictate when a purchaser will make an offer, secure their mortgage or persuade their solicitor to finish asking questions.
In the meantime, the development finance clock keeps ticking.
A developer shouldn't necessarily have to choose between accepting a disappointing offer and continuing to pay expensive development finance.
Sometimes, reviewing the funding arrangements can provide the breathing space needed to achieve a more satisfactory outcome.
And that's potentially good news for the developer and the estate agent alike.
Development exit finance isn't simply about cheaper borrowing
Development exit bridging finance is designed to refinance developments that are complete, or in some cases substantially complete, while the properties are sold or longer-term arrangements are put in place.
The obvious potential benefit is a reduction in borrowing costs.
But in my view, concentrating exclusively on the interest rate misses an important part of the picture.
For many developers, the real issue is capital.
A substantial amount of their money may be tied up in completed properties, even though the development itself has been successfully delivered.
Meanwhile, the next opportunity may already be presenting itself.
Another site. An attractive acquisition. Perhaps a project where timing is particularly important.
And, as most experienced developers know, opportunities don't always arrive at the most convenient moment.
Depending on the valuation, existing borrowing and lender criteria, a development exit facility may allow some of that equity to be released before the completed properties have been sold.
That capital could then potentially be used towards the next project.
In other words, development exit finance can be about much more than finishing one project. It can help create the opportunity to start another.
Sometimes the best advice is to do nothing
Now, this is where I think experience and a little perspective become particularly important.
Not every completed development needs refinancing.
If sales are progressing well and the existing facility is approaching repayment, the costs of arranging a new loan may outweigh any potential savings.
There may be exit fees, valuation costs, legal expenses and new arrangement fees to consider.
Equally, releasing additional equity isn't automatically a good idea simply because a lender is prepared to offer it.
Additional borrowing brings additional costs and obligations.
The important thing is to understand the developer's wider circumstances, their plans for the next project and what they're actually trying to achieve.
During my years in private banking, I was frequently reminded that clients with substantial assets can have very different requirements when it comes to liquidity and financial flexibility.
Property developers are no exception.
For one developer, reducing monthly interest costs might be the priority.
For another, releasing capital to secure the next site could be considerably more valuable.
And for someone else, the sensible course of action might be to leave the existing finance exactly where it is.
Good financial advice isn't always about arranging another loan. Sometimes it's about recognising when one isn't needed.
A conversation worth having before the development is finished
One of the things I would encourage developers and their professional advisers to consider is the timing of these discussions.
Too often, refinancing becomes a priority only when the existing development facility is approaching its repayment date.
By then, the developer may have fewer options and less flexibility than they would ideally like.
Wouldn't it make more sense to review the exit strategy as the development approaches practical completion, rather than waiting until the loan is nearing expiry?
That doesn't mean committing to a new facility unnecessarily.
It simply means understanding the options, the likely costs and the potential benefits before a decision becomes urgent.
And, in my experience, having options is rarely a bad thing.
A final thought
Property development is ultimately about making the best commercial use of capital.
Developers understandably devote considerable attention to land acquisition costs, construction budgets, professional fees and the eventual sales values.
But the financing arrangements between practical completion and final sale can also have a meaningful impact on the profitability of a project.
It's a period that deserves some careful thought.
After all, the purpose of development finance is to help get a development built.
Once that's been achieved, perhaps it's worth asking whether the finance has finished its job too.
Jeff Durant
Commercial Property Finance Specialist
Over 40 years' experience in property and commercial finance, spanning banking, private banking and specialist finance brokerage.