In the past 18 months, there has been a sharp rise in development finance providers, including a notable number of bridging lenders.
While an increase in funding options seems to be a positive trend for borrowers, we are seeing that this product shift can be imperfect.
At Avamore, we’ve been asking our clients what they value most and they’ve told us it’s having access to a decision-maker; clear and open communication throughout the process; and being able to trust your lender to perform.
Bridge lenders have been drawn into the development finance business mainly because the cost of borrowing for bridging customers has fallen dramatically, even for non-regulated cases. Most bridge lenders have a fairly static cost of capital (relative to the market), so reduced rates result in squeezed margins and reduced profitability. Development lending can offer better rates of return than bridging in today’s environment – hence bridging specialists’ recent attraction to the sector.
This trend could have an adverse effect on a borrower’s experience in development finance. At Avamore, we consider development lending as more of a service compared with bridging, which is comparable to a commodity, or a function of who is offering the best price and/or loan-to-value (LTV) ratio. Development loans are generally more complex, with a need to factor in risk prior to making a first land advance.
It is also important to consider factors such as the loan-to-gross-development-value ratio; loan-to-cost ratio; developer’s experience; type of product being developed; construction methods and planned procurement route; and whether the developer will make enough profit to remain motivated in the face of a challenging situation.
Notwithstanding these specific requirements, we have seen the consequence of borrowers and their finance brokers opting for loans from lenders with inappropriate experience, which might appear cheaper or offer higher leverage but are structured in a way that is detrimental to the progress of the project.
An example is when lenders take an aggressive approach if projects overrun expected practical completion dates or if development drawdowns are valued by a RICS ‘red book’ valuer instead of a project monitoring quantity surveyor (our preferred method of valuing work carried out on site). The outcome can be catastrophic for development projects, which usually need regular cash and can face challenges requiring a knowledgeable and patient lender.
It is not just the loan structuring that requires experience. Bridging finance is generally more ‘hands off’ during the life of a bridge loan. Bridge lenders may not have experienced the early warning signs that suggest a project could be running into trouble.
After completing a development loan, Avamore requires regular management and consistent monitoring to keep developers motivated up to completion. We often see over-ambitious developers focusing on buying the next site rather than building up recent purchases; good management ensures they retain the right focus.
Many potential issues can be avoided by proactive management as opposed to being reactive when things go wrong, when decision- making can be rushed and often irrational.
In short, development finance clients should consider the entire package, not just the rate or LTV ratio. During development, things inevitably change and a lender must be prepared to be dynamic and flexible. The opportunity cost – and reputational cost – of a stalled or failed project is dramatic and it is important to be mindful of that when sourcing funding.