Development Finance: Focus on the overall value proposition rather than pricing

Development Finance: Focus on the overall value proposition rather than pricing

This story was updated on July 6, 2020 at 10 pm

Parash Sarma

Auckland, July 5, 2020

The post Covid-19 environment is throwing up new challenges for builders and developers, as all lending institutions, bank and non-bank alike, try to make sense of the overall impact of the pandemic on the economy and property values. 

Mainstream banks have limited appetite to fund development projects; the credit criteria which was fairly tough pre-Covid has now been tightened even further effectively making most builders and developers ineligible for funding.

Dwindling liquidity

In the non-bank market, liquidity has been affected and funds available for development projects have dwindled significantly. Most lenders are taking a very conservative approach or preferring to wait till the “dust settles” and some normalcy returns to the market.

Given the challenging environment, it is critical for developers and builders to conduct due diligence on the lender and ensure that the lender they select to fund their project has the necessary expertise and financial strength to carry the project through to completion.

All too often, the key criteria for selecting a lender appear to be the headline interest rate and fees; the focus however should be on the overall value the lender provides and not just the finance cost.

Lender profile

As a borrower, one should view the funder as a project consultant and ask similar questions of the lender as they would of the other project consultants such as planners, architects, engineers and contractors. If you are a developer or builder considering development funding, you should focus on the following:

Experience:                        How long has the lender been in business?
Track Record:                   How many developments have they funded?
Specialisation:                  Are they specialist development and construction funders?          
Conditions:                        What conditions would they typically require?
Hidden costs:                   Are there costs other than headline interest rate and fees such as line fees, exit fees etc.

The other very important check is to ask around- if you know someone who has borrowed from a non-bank lender find out about their overall experience- would they consider funding their next project with them?  

Important factors

Pricing, while important, is just one of the many parameters that should be considered while applying for development and construction finance. There are other equally important factors such as:

Flexibility           

Does the lender have a “tick the box” approach or do they have the smarts to assess risk based on merits of each specific deal? For example, does the lender always require pre-sales or are they flexible enough to waive the requirement of pre-sales if the product being developed has already been widely accepted in the market and is in an established area; or can the lender waive the requirement of a Quantity Surveyor if the client is an experienced master or certified builder? It is very important to remember that every condition has a cost associated with it- for example, a valuation may cost $1500 but it may also take 10 days to get a valuation, i.e. the project is delayed by 10 days.

Hidden Costs

Look beyond the headline costs. There are often many costs which may not be apparent at first glance but add up to significant sums over the course of a project. For example, a line fee of 0.25% per month is 3% per year. On a loan facility of say $3 million, that is $90,000!

Processing Payment claims

One of the key questions that a developer must ask a lender is the turnaround time to process a payment claim. For example, let us assume a development scenario where the development will require eight progressive drawdowns. The client has a choice of two lenders- lender ‘A’ requires a Quantity Surveyor and usually takes seven days to process a payment claim. Lender ‘B’ is 1% more expensive but does not require a Quantity Surveyor and can process the payment claim within 24 hours.

If a developer chooses lender ‘A’ based on price, the project will take approximately two  months longer to complete (that is two months additional interest cost) and also cost between $8000 to $10,000 for Quantity Surveying.

Successful developers focus on the “value proposition” rather than making a decision on the basis of pricing alone. As Warren Buffet famously said- “Price is what you pay, Value is what you get.”

Parash Sarma is Client Services Director at ASAP Finance Limited based in Auckland. He can be contacted on 021-864730. Email: parash@asapfinance.co.nz; ASAP Finance Limited is a Sponsor of the Thirteenth Annual Indian Newslink Business Awards 2020.

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