Experienced property developers know their business and the pitfalls and are good at managing risks – so the ultra-cautious response of many lenders to requests for funding causes frustration. Many forms of property finance have returned to something near normal over the last year or so, but lenders are still reluctant players in the development market.
The reason is that property development is not easy – a lot can go wrong. Otherwise anyone with vision, project management skills and access to money would be doing it.
It is also true that bankers don’t always understand development to the depth needed – most High Street banks rely on a relatively small number of individuals who have the intensity of experience needed – and it is an area where ‘a little bit of knowledge can be a dangerous thing’.
So the banks deliberately contain their lending to ‘accredited’ managers and underwriters – which creates a constraint in how many deals can be done (in addition of course to availability of capital). But most of all bankers lend on experience of the past – and when something goes wrong on a development it can go wrong for the bank.
Here are a few real examples:
- An industrial unit development stalled at demolition stage when a boy broke into the site and found a sand lizard. Naturalists stopped the next phase of work for over a year and the bank found themselves lending an increasing amount against a site which then had questionable value.
- An inexperienced developer, but nevertheless a good business customer of the bank, decided to make a subtle change to a four house development for which he didn’t have planning. Planners picked up on it and the development was significantly delayed.
- The first four units of an eight unit residential development were completed but didn’t sell due to a downturn in the market. A banker’s priority in this situation is to see an exit to their loan, so their logic is that you reduce the pricing. A developer’s priority is to preserve the return on capital and not to reduce prices for the early units which will depress the prices for the whole development. They couldn’t agree and an alternative lender had to be found.
- A developer didn’t properly consider ‘Oversail Rights’ when using a crane. An adjacent property owner objected and a dispute resulted, causing legal costs and delays.
- A developer’s lawyer didn’t properly explore a covenant on a plot of land. The deeds didn’t express the nature of it and the opinion was that it would be an insurable event, but it was a historic restrictive covenant which a neighbour understood and used to hinder the development.
In all these cases the developer suffered a loss of profit through delays or costs – all part of the risks of the business and all these situations could have been prevented.
However the point is that they all caused the bank to question the continued viability of their lending and led to a development ‘going wrong’ in a banker’s eyes and exerting pressure to achieve an exit. Such situations lead to wariness in developing criteria/policy, with reduced LTV’s to create contingency headroom and increased pricing for risk, plus of course limiting lending to only ‘seasoned developers’ who are less likely to make mistakes.
The result: only seasoned lenders in High St banks will deal with seasoned developers who they already know – the gap in funding is then typically filled by specialist property lenders or investors with property experience.
Our job is to find the best possible fit between a developer and a seasoned individual in the lending community. This also involves making a value judgement on how a lender will react when things go wrong and getting the right amount of borrowing at the right rate to achieve the desired return on capital.