4 ways to increase profits from your lender

1. Are you using the right type of debt?

The differences between senior, stretched senior and mezzanine debt are hugely impactful in the profit of a deal and the return on equity (ROE). Some large, well known banks may appear very keen to look after their clients with development finance – however, if their loan to value and loan to cost ratios are low – a developer must use considerably more of their own equity, therefore reducing their return on equity.

We helped a developer recently move from their (wealthy-) family friendly bank to a boutique development lender. Though their rate was around 3% higher per annum, they were happy to lend 80% LTC (whereas the others would only lend 60%). As such, on £1m cost project, the developer was able to increase thier projected ROE from 50% to 100% by using less of their own equity.


2. Do you understand the actual cost of debt and fees?

If ever headlines can be confusing…. Many lenders will advertise their “headline rate”, which in development finance is commonly best expected to be 6-8%. Other lenders may charge 12%. If you bought the first one, you may have missed out – “cheap” debt very rarely actually costs less but is marketed to appear more appealing. Lower debt costs typically come with strings – very high Personal Guarantees, low Loan-to-values, restrictive day 1 loans and mostly – high “in” and “out” fees being the costs to arrange and exit the loan. Often, higher headline costs can be more cost effective in the life cycle of a deal. 

Example: 6% vs. 8% on a £1.2m GDV project.
On a £1,000,000 loan for 6 months, an 6% rate with a 2% exit fee would cost £54,000.
The same amount and duration at an 8% rate with no exit fee would cost £40,000.
The “cheaper” loan therefore cost 35% more.


3. Do you need to raise mezzanine debt or equity?

A client recently came to us looking to raise a £1.5m equity loan to make up the cost of the project they were not able to fund. After breaking down their appraisal, we were able to model their deal with the same size loan as a mezzanine facility. The difference was, with the equity loan, they would have given away about 55% of their profit (£2.2m) but the mezzanine facility for 2 years at 16% cost £480,000. This saved the developers £1,720,000 in profit.


4. Is your lender actually motivated to lend on property?

Appetite for property development finance changes with the market like it does a season. In boom time, everyone is lending and tripping over themselves to reduce their rates in order to deploy their balance sheet for some form of return. In leaner times (post 2009, 2014), belts tighten, rates increase and loans get called in a lot quicker. Those lenders that come in and out of their development finance market are generally to be avoided as their boards will panic at a market turn and call in loans – which you do not want. Ever. Specific development lenders are more aware of market fluctuations and therefore intend to look after their clients in the long run – anticipating these variances.

This story is listed in: Investment, Property development, Property Investment, Property Market

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