Why Your Development Finance Was Rejected

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Monday, April 25th, 2016
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I regularly get contacted by desperate developers wanting to fund their project, frantic because they have committed their time, funds and or equity into a project only to find out that getting the funding is not easy.

Some of these developers are new to industry and it is rather expected that they may have trouble or perhaps have not yet learned the right way to approach funding a project. However, some are experienced developers that have been caught in the changing funding environment.

Below are some of the reasons why they run into trouble:

Bank appetite for funding developments has reduced

Banks have traditionally been the major source of property development funding. However, the appetite of the major banks is waning. Banks are tightening their lending criteria and requiring higher amounts of equity (lower loan to value ratios), profit margin and a larger amount of pre-sales, up to 100 per cent of debt cover, especially for inexperienced and new to bank developers. Some areas are now effectively off limits for bank development finance due to concerns of oversupply.

Furthermore, the major banks may impose further conditions/restrictions on developers above and beyond their stated criteria in order to further mitigate their risk. This can mean extra time is taken whilst the bank assesses and re-assesses the risk or all of the different aspects and this can cause delays for the developer who just want to get on with their developments and making money.

The tightening of bank requirements is pushing more developers who are sick of trying to jump through a seemingly never ending series of hoops from the banks to non-bank or ‘private lenders.’ These lenders have a more flexible approach to funding developments and allow developers to have much lower equity contribution (and higher loan to value ratios), many do not require pre-sales and are generally much faster than the banks at approving and releasing funds.

On the flip side, when you are using a non-bank or private lender, you can expect a higher cost to go with the greater flexibility and risk to them. For many developers, the extra cost of using a private lenders is not significant compared to their profit margin and when their equity is freed up (as private lenders can accept lower equity contributions) they can use this equity to do other developments making it overall a more profitable option.

Your experience as a developer

If you are an inexperienced developer, funders will treat you with extra caution. This can mean that lenders want extra conditions on you to reduce their risk or if you take a private lender option, you may end up paying a higher interest rate. Having an experienced development project manager on your team can allay the lender’s fears somewhat, but quality project managers do not come cheap and it may not be economical to have a project manager for smaller development projects.

Your builder

If you have a cheap but dodgy or unknown builder for your project, this can spook your funders. Even without funders in the picture, a dodgy builder can be an endless source of headaches for you with time blowout issues, quality of construction issues and cost blowout issues. On the other hand, a good builder can mean that things run more smoothly and with small development projects they almost run themselves. Regardless, your funder is likely to reject your funding if they don’t like your builder. Having a dodgy builder on your team can also erode your credibility with the funder as you may have made other bad choices in assessing and planning the development.

No (or flawed) feasibility study

Some inexperienced ‘developers’ think they can just buy a site that can be subdivided and the banks and lenders will throw money at them to do a development. This may have been true at one time, but in today’s economic climate, it is no longer possible. To get funded, you need to have a feasibility study that demonstrates that the site can be developed and what you are developing will sell and make a profit. However, you can’t just make up flawed numbers to put into a feasibility study. For example, sales prices must be researched and justified based on comparable recent sales and not just those that sold at the top price point. Make sure you consider the true costs of all relevant factors as items like taxes/levies, marketing costs and contingency are often overlooked. There is proprietary software available that can help ensure that you did not overlook anything but it will not make sure that you entered the correct amounts.

Shopping your deal around

Shopping your deal around can be a killer. It is a bit like applying for a home loan to every bank and lender – you will destroy your credit file and have all of the lenders wondering what is wrong with you or the property/deal. Ironically, by shopping around for a better/cheaper deal you may end up with only being able to get an expensive option.

Missing or incorrect information

Wrong information on your application is a big no-no. Even if you have been bankrupt before, there are lenders that will fund you. If you omit that you have been bankrupt, however, it is likely that you will be found out. Then you will have trouble as the other aspects of your finance application will not be considered credible, thus making you higher risk.

Pre-sales

As mentioned above, pre-sales are a distinct advantage and a prerequisite for many lenders. If you have sufficient pre-sales to cover your debt, then you are seen a lower risk. You don’t want to be stuck with a lot of unsold stock at the end of the development only to find that you are unable to sell it yet you need to sell to repay debt. Getting pre-sales at the concept stage of a development can be more difficult, however, as it is easier to sell something that exists or is taking shape and people can see and imagine rather than a vacant block. Getting pre-sales can also take time and may delay your project start if you have insufficient pre-sales to satisfy your lender.  This is another situation where a private funder that does not require pre-sales can mean that you get your project going.

Of course, there are many other factors that can end up getting your finance rejected by a lender. In many cases there are private lenders that will accept you if you have a profitable development, but the cost of borrowing is likely to be higher. In fact, with good development using private funders you could end up funding 100 per cent of the development cost without having any pre-sales.

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