#SQFT 9: Financial Deal Analysis and how to secure Development Finance


Sierra Whiskey has, to date, been involved in 14 property development deals, which have in turn produced multiple units per deal.

In order to do these we have used all possible means of finance. In the early days, this meant residential mortgages and borrowing development funds or doing a Joint Venture with a contractor. Moving into larger deals, we managed to find some High Net Worth individuals who were willing to 100% fund our deals for a profit share. As in previous posts, these can work out well but can cause some difficulties that may be preferably avoided due to a lack of total control which is vital in managing the outcome. What is important here is understanding the different methods of raising finance to see what works best for you – which is highly driven by your risk tolerance and level of comfort.

Our position now as a Venture Capital-based model is to secure deals, raise debt and then raise equity in order to execute the deal. Our preference is with boiutique debt lenders which are smaller, usually privately backed companies that focus exclusively on property development lending to small companies and individuals. Their interest rates can be high (10-12%) but their understanding of the challenges met can mean great flexibility. We have found there are vast differences in debt lenders across the market form larger commercial banks to the smaller boutiques. An understanding of how debt lenders work (with particular focus on their terms) is absolutely imperative to be understood by a developer. We have experienced positions taking loans form very large British banks who have failed to deliver development loans due to a lack of liquidity on their behalf. While this caused significant problem, it also taught a vital lesson in understanding the feasibility of lending. In early days, we would highly recommend meeting as many debt lenders as possible (Google is your friend here – “London property development debt lenders”) to understand the similarities and differences in them. What is important to gauge in order to measure one against another is:

1.Their headline interest rate.

2.Their “in and out” fees – fees they charge at the beginning and end of a loan.

3.Their Loan to Cost (LTC) – the percentage they will loan relative to the entire cost of the development. This is typically 50-80%.

4.Their Gross Loan To Value (LTV) – the percentage position they want to be in when the deal is finished (typically 65% – so the money they put in makes up 65% of the value of the whole asset on completion).

5.Do they require Personal Guarantees (PGs) and how much for. You will have to give these in nearly all situation to prevent you from running away from the deal.

6.What Due diligence (DD) they require. Usually this involves Legal, Quantity Surveyor and Valuation reports on which to base the loan amounts and how much they will cost you (not them).

7.What happens if you exceed the loan amount or loan facility period. DON’T gloss over this now!

When this data is compared against 5 different lenders, you will likely know which you prefer.

Knowing many prople know in the debt industry, there are multiple horror stories we have come across. It is not uncommon in private, non-regulated lenders to have a position known internally as “loan to own”. What this means is a lender will finance a property development knowing a developer is likely to run out of funds, allowing them to repossess the property at far below the full costs (as all developers equity is no longer present). This will then be “taken over” by a director, privately, in order to execute the deal and realise the now substantial profit. While this might sound incredibly crooked, it is a regular occurence and factor of an industry that seeds huge ego and greed. It is so imperative to understand  and know well how a development lender works and their track record of repossessions. Whilst always being a rush to secure finance, the very important scenarios to establish with a debt lender is their likely actions should you not sell your site entirely in the facility period (which will have been fixed at the start of the deal), and how they will react should this occur – which is so easily can in scenarios such as dropping markets. A reasonable lender will negotiate an extension on your facility which may cost more but that is a factor that must be understood before signing on the dotted line. This is not intended to scare younger developers but a recommendation to be aware off

As with any individual equity parter, the relationship with a debt lender can be worth huge financial security and peace of mind due to factors affecting that can be out of your control.

When structuring deals, it is very difficult to compare bank debt against that directly from an individual who may wish to fully fund your deal themselves. This is because bank debt is set up with such legal parameters that they will do strict due diligence on both the individual and the developer but also have legal templates and frameworks to cover eventualities where the scheme does not go entirely according to plan – such as a cost or time overrun. This will not likely be in existence with individuals as they can look to strong arm their position and take control of a property, leaving the developer in a weak position despite problems potentially being out of their control. It is possible to do these deals but relationships and legal frameworks must be put in place and understood before lending is made. Getting “burned” in this situation is not uncommon at all – so do your homework. While a bank loan may seem significantly more complex, the due diligence and framework will have the effect of keeping you honest and your optimism in check. Sometimes we all need this.

The biggest controlling factor in debt lending is the asset ownership or “first charge” which a bank will, without doubt always impose and an individual lender may also insist upon. You have a far better position to negotiate the split ownership of the asset (after the banks charge) with a sole equity investor. This gives you both control of ownership behind the bank.

Past Scenarios

We once had a deal in Kensington for the addition of an extra floor onto a property. The sales representative of the large British bank (who shall remain namelss) painted a very simple picture of their debt facility for property developers. While many months evaporated getting their facility in place, I would not use “simple” as a term associated with this bank. On finalising our Land loan, we commenced build work on the project and after a very uncomfortable 2-3 months of construction, realised tht this bank was not actually able to satisfy the development loan facility meaning that we had contractors that needed paying and a bank that kept making excuses about why they had not sent funds to us.

In this situation, we were forced to approach a private bank to raise a loan backed against the property – which was not ideal. We then removed the first bank from lending on the development facility. Looking in detail at the loan terms, we realised that with fees and charges, when we added all of the costs of the initial bank and the % of GDV they were lending against the deal (55%, very low) – they were a total rip iff. As such, we felt it our duty to renegotiate terms with that bank on the land loan seeing as they had failed to uphold their contratual loan. Perhaps being part tax payer owned put’s one’s arm behind thier back with regards to higher risk property development funding. Needless to say, that bank did not get the 2% exit fee that they were expecting to on closing the loan. Large banks can be appropriate for loans above £2,000,000 but below this level (and sometimes way above it), smaller lenders are usually far easier to work with than banks.

3 tips for up and coming developers

1.When presenting a property development deal, always thoroughly lay out your deal projections and numbers on a spreadsheet. This is vital for any credit department to analyse in order to sanction your loan. Most importantly, they will inspect your downside projection and what contingencies you have in place. If you have skimped on these and under allowed with a sense of optimism, they will pull you apart and you are not likely to be lent funds from that house again. Always over-allow – if it does not make the deal look profitable, perhaps rethink whether it is actually a good deal to invest your time and investors money in. Emotional attachment does happen as we do not want to drop a deal and so proceed with hope as a strategy. Without a stable profit outcome, it is not a deal.

2.Always prepare a full information pack alongside this Excel spreadsheet – this is your opportunity to tell a story. People like numbers but they prefer a story as to how you came about finding this opportunity with a profit margin in it. Explain how you found it, why you believe there is a margin and a little bit of background information about the property, the area, who you expect to buy this type of proprty and the comparable evidence you have for any planning permission and previous sales in the area which would support your expected slaes prices.

3.When you receive Headline Terms (“Heads of Terms” / “HOTs”), this is a document setting out how much they intend to lend you, the criteria on which the fund are being lent to you and, most importantly the due diligence that must take place in order for them to confirm these loan amounts will be made. These headline terms are based on your projections but their loan will be based on the due diligence by professionals such as quantity surveyors, and valuers. If their numbers come in lower, that is what the loan numbers will be based on, not your projections. So get this right. Heads of terms can usually be relatively simple and straightforward and as simple as  one to two pages. Full  lending contracts (when you are signing for the loan) however can be extremely long. It is vital when considering Heads of Terms and full lending contracts that you take specific legal advice on all the intricate details – less so of what happens when you achieve a record price, more so what happens when things don’t go quite to plan. You must know absolutely what should happen should these problems occur in a deal. If that is at all uncomfortable, seriously reconsider whether this deal is worth it. The upside could seem attractive but make sure you understand the downside and you are far more likely to be a successful property developer.

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