"Developers have incredible expertise when it comes to building property, but that doesn’t necessarily mean they’re experts at financing projects"
- Robert Sadler - Excellion Capital
Create an organised business plan that will resonate powerfully with a lender.
When approaching a lender for debt financing, it’s important for developers to have a crystal clear strategy laid out in a well-organised business plan which outlines how the project will be financed, constructed and, ultimately, exited.
When a loan application is packed full of information but lacks proper organisation, the lender is required to do a lot of extra work in order to properly understand the proposal which can greatly hamper the application’s chances of success.
As well as presenting a well-organised business plan, developers can also improve a proposal by ensuring it is written in clear, concise, and accessible language – it’s common for developers to present plans that make perfect sense to them, but remain impenetrable for anyone else.
Finally, developers can avoid common loan application pitfalls by checking, double checking, and checking again that they have included everything the lender expects to receive. This includes a comprehensive structure chart that reassures lenders that the organisation adheres to their minimum UK ownership requirements.
Developers can enlist expert guidance from a debt advisory firm to ensure that their business plan contains all the necessary documents topped with a clear summary for lenders who are often so inundated with lending opportunities that a poorly organised loan application will be sent to the bottom of the pile and risks never being read at all.
Maintain realistic expectations of leverage
Many lenders advertise incredibly high leverage – often up to 85% of costs – but rarely actually provide this in practice. Because of the way lenders advertise, developers understandably expect to achieve high leverage when putting together an application and are frustrated or thrown off course when the lender fails to approve the loan.
In extreme circumstances, when a developer has written their entire business plan based on the higher leverage, they may have to abandon the project altogether when their expected loan amount is denied. While developers can hope for the best, they must always include contingency plans for what happens if the highest leverage is not offered.
Take care to understand the level of risk you present to lenders
Some developers will apply for loans with an expectation of receiving cheap financing based on a belief that their project is, for example, a core or core plus investment, when in fact lenders are likely to class it as a value-added investment.
For example, if a developer has purchased an opportunistic asset and gone on to complete all necessary construction or refurbishment works, etc, they may want to move on to more standard investment terms, assuming the works completed now make the development a core asset. However, in the eyes of the lender, the asset is value-add at best due to the fact that further work is still required to maximise income.
In other words, when setting expectations for how affordable loan terms will be, the best developers have a clear understanding of what category the lender is going to place their project in and, therefore, have a good idea of what kind of price they’re going to achieve.
Be cautious when it comes to excessively high leverage
Drawing a loan at excessively high leverage creates the risk that a developer will be unable to exit the project cleanly on completion. So while it might result in a loan that allows for the project to be finished, it leaves very little wriggle room when it comes to repaying the loan.
And this wiggle room is more important today than ever before. Prior to recent base rate increases and soaring mortgage rates, developers could reasonably expect quick and profitable sales. But given current economic conditions in the UK, there is a much greater risk that sales will be slow or rental income will be lower than expected.
Taking on a loan with excessive leverage that forces you to rely on strong future sales or rental income makes you a hostage to fortune, and the modern world has proven many times that it cannot be relied on to be predictable.
Maintain realistic loan expectations and don’t shy away from guarantees
When issuing large loans at high leverage, lenders will usually insist on implementing guarantees and cost contingencies to reduce the amount of risk they are exposed to.
However, a lot of developers who request high-leverage loans remain reluctant to accept these guarantees (or they may have a shareholder structure that cannot provide them), even though the guarantees rarely result in any price increases and are generally non-cash risk mitigants for the lender. But by refusing them, developers are limiting themselves to far more conservative loan amounts which can, in some cases, have catastrophic consequences for the project in question.
To avoid this issue, a developer must either be prepared to provide more equity or draft a business plan that either assumes conservative loan amounts or accounts for the guarantees that the lender will insist on.
“Developers have incredible expertise when it comes to building property, but that doesn’t necessarily mean they’re experts at financing projects," explains Robert Sadler, Vice President of Real Estate at Excellion Capital, "As a result, even the most seasoned property developers can submit loan applications that fail to satisfy the lender’s credit committee,"
"Financing a development project and securing debt financing is equal parts art and science," he adds "Science leads the way when developers are identifying the best and worst case debt scenarios for their projects and formulating sound plans for both outcomes. But then art must take over to ensure that the subsequent business plan and loan application are pieced together and presented with language that is both pragmatic and enticing, giving a lender confidence that a project will succeed while also eliciting an element of excitement that this is an opportunity they want to be part of.
Sadler concludes, "As a real estate debt advisory firm, our job is to first understand a developer’s loan requirements based on the scale and nature of the project they are looking to fund, before working with them to identify all potential pitfalls and stress points in order to ensure that they are only taking on debt that is manageable regardless of how a project’s internal and external conditions may change.
"We then take their application to lenders in a process of professional negotiation that ensures our clients secure the right loans at the right price to enable a project to be completed and exited with minimal risk and maximum profits.”
