#SQFT 11: Ten things you need to get bank funding in property development

Bank funding is a complex process but necessity in raising debt for any property development deal. The biggest flaw in the marmet is that there is no manner to learn about bank funding other than trial and error. This might mean a few small embarrasments at learning how the  process woks but could mean huge financial impications if done without full understanding of the strict critaeria attached to lending. Banks will always ensure they have full and entire control over any deal in order that they can step-in and control it should the developer fail to perform – in order to protect thier funds. As such, while many are very keen to lend their funds in order to realsie a return for their balance sheets, their interest in you is secondary to getting their money back and the interest on it.

The following is a realiable check-list of what you need in order to raise ban funding on your development:

1. A Track Record.

All banks and senior debt lenders will want to see that you have some experience in what you’re proposing to do. This may seem like an impossibility if you at the early stages of property development but as with setting up any business; beg, borrow and fabricate. While you may not necessarily have a good deal history (how could you if you are starting out in property development?),  you need to display to the lender that you have an understanding in your financial model, the local market and the factors that will affect profit. Many people coming into property development have done so successfully from a financial or accounting background as this shows a clear understanding of the numbers which govern a deal. Some exposure to property will be required or the bank will find multiple holes in your business plan. If nothing else, show a history of you modelling deals, understanding of and exposure to the local property markets and deal analysis even if you have not purchased any properties as yet. We’ll have to start from somewhere!

2. An actual deal.

Approaching a bank speculatively might seem pointless without a live deal – it is still advisable. While an initial conversation is useful in understanding the bank’s lending terms and criteria, it is far more better to have even a hypothetical deal to show that you understand this process. Having a deal model that may not actually be real will allow the bank will find any holes in your spreadsheet analysis and deal information pack. It is better to have these on a hypothetical deal than a real deal so you are aware what factors to focus on with an actual deal. When you do find purchase at an attractive price, the world will turn upside down in terms of the speed that you must move in order to realise the purchase and pressure will be coming from all angles. Having a good contact and understanding lending criteria from the bank will smooth is this process out greatly. Banks can act very quickly in sending out lending terms, but this is all dependent on the depth and quality of information you provide. After 10 years of developing you will still find holes in your own models.

3. A thorough understanding and display of costs.

Your spreadsheet is king. Ensure you have been through it multiple times and understand how all figures and sums are arrived at and where they are derived from. You will be pulled apart on anything that does not make sense or cannot be explained easily. Use colours and neatness to show simply how are you have built up your gross development cost through acquisition, development, finance, and disposal. Show your Gross Development Value and be ready to prove how you have arrived at this, and then what total Profit on Cost you expect to make (and be sure it is at least 20%). Before you show your spreadsheet to anyone, take off your optimistic hat and replace it with that of a pessimist. The bank wants to know that you understand what could go wrong not what might go right.

4. Personal Guarantees.

When borrowing any significant sum of money, it is highly likely that the developer ordeal promoter will be required to give a personal guarantee. This is not uncommon and is protection for the bank that you as the manager of the development, you will not walk away from it should things turn sour – so be prepared to give that personal guarantee. If this feels uncomfortable, you must ask yourself if you’re actually confident in the deal. While some banks ask for a 100% personal guarantee, the acceptable level is about 20% of the gross loan. Ensure you understand the legal implications of the personal guarantee and take legal advice as they will be in legal documentation form.

5. Equity backing.

A bank will typically lend 50 to 80% of the costs of your development – as long as when completed, their funds represent no more than 65% of the gross development value. As such you will need to show you can raise the other 20 to 50% of equity to make up the gross development cost. Commonly when young developers are starting out, they will not have this level of funds freely available – which is a good thing. In such an instance, you will need to raise this amount of equity from another individual with deep pockets. The reason this is a good exercise, is that an equity investor will lean heavily on your deal plan, forcing you to ensure there is profit available even in the worst circumstance. The bank or lender well then commonly undertake due diligence on this individual as well as you and they even asked for a personal guarantee from them. It is important to remember that all equity goes into a purchase before a bank lends anything, and all debt comes out before any equity profit. This is not negotiable.

6. Skin in the game – not always.

A factor that holds back many young developers, is having money to put into deal. This should not always be a requirement as the relationship with your equity investor needs to be based on transparency – if you are starting out in this business it is highly unlikely you’ll have the cash. A useful point to explain to investors is that while they are committing their capital, you are also committing a commodity in the form of your time – and a lot of that. If you equity investor or bank is not willing to proceed without your skin in the game – walk away and find another, there are plenty who want to deploy funds and they need people like you to bring these opportunities to them.

7. A contingncy.

A contingency in both costs and time is vital to be shown on your financial model. It is a guarantee with a early developments that you will overrun on cost and time – often by factor is entirely out of your control. Showing that you have anticipated this gives huge confidence to those lending money into the deal. If you’re having to remove contingencies to make your numbers work, wise up and drop the deal – it will only become painful experience in 12 months time. A contingency can be calculated as roughly 20% of build costs and 25% in sales period.

What is more impressive to support your financial model is a stress test on your numbers. Taking your financial model, display a scenario in which your bill costs are elevated by 20% and your gross development value is reduced by 10%. If your development still shows any profit in this environment you have a good deal and have displayed the awareness of a worst case scenario.

8. A “Plan B” or “Car crash” scenario.

Property development is not about creating beautiful houses. Is about numbers as a constant game of chess. There are so many moving parts in each development deal that will make constantly shepherding in the right direction. Certain factors such as planning permission are beyond your control. Before you present you model, ensure you have shown all risk mitigation factors – effectively what could affect the profit of the deal. This list will be made up factors that affect profit in small and large ways. Everything outside of your control has the capacity to go wrong – so the more scenarios you can display should this happen – the more secure a deal you have to present. Such factors can include (but are not limited to) planning permission, freeholders, Licenses to Alter, contractors, pricing, the market, the economy, neighbours and delays. Always have a plan B.

9. A bank that wants to and will actually lend.

This may seem like odd statement. Many banks however, have and appetite for higher risk investments (which property development is), but may not actually have the funding easily available. We have learned this the hard way with one of the largest UK banks lying to us about why we could not drawdown a development loan. Doing due diligence on banks is near on impossible; as such it may always be better to work with small, bespoke property lending institutions. With many lenders, there is urgency to lend on schemes but delays can occur on actually signing off funds internally. Ask as many probing questions to a bank’s representative about what processes have to be gone through for the sanction of a loan – you cannot ask enough questions and must be entirely comfortable with a process before commencing with it.

10. A good credit history.

Finally, but just as importantly – any lending institution will do their due diligence on you as the developer or deal promoter. They will turn over stones and find out about your history – so if anything is less than clear, always declare it immediately. All banks will want an up-to-date credit report, so ensure your credit history is as clean as possible by checking it through one of the main credit scoring agencies. It can be surprising what has given you bad credit historically that can be easily rectified. This can take time however so ensure you do this proactively.

This story is listed in: Investment, London Property market, Property development, Property Investment, Property Market, Uncategorised

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