In the past month or so I’ve seen an increasing amount written in the trade press about development finance. Two of the major specialist short-term lenders in the market have recently been out in the market promoting funding they have available specifically for development projects. Their timing is interesting I think.
In my career before Fincorp I spent eight years at specialist development finance lender Wintrust. And indeed when I first started at Fincorp we had a specialist line devoted to development finance. We stopped doing it because we could see better opportunities for our investors on the bridging side. But we have a long history in the development market and a deep understanding of it.
Development finance is inherently riskier lending than a bridge, even one taken to do heavy refurbishment work.
For a start developments require specialist valuers to assess the cost of build. There are all kinds of issues that can arise on out of the ground projects that you just wouldn’t even consider on a refurb deal. One example that springs to mind was a developer planning to build four miles from the nearest drainage system – the cost of extending the drains to beneath the property made what at first looked like an attractive deal completely unworkable.
Projects that haven’t yet begun also take a completely different level of managing and commitment by developers and lenders have a lot less wriggle room if things take longer than expected. And where property development from the ground up is concerned, it nearly always takes longer than expected.
The real danger from the lender’s perspective is that the developer’s profit margin is eroded by delays in the project. If a developer is managing a project with the prospect of making a whack of cash for himself at the end he has a vested interest in keeping things going at a fair lick. Once that profit is lost, developers tend to lose interest.
Lenders run the risk that they suddenly need to be on site three mornings a week to make sure things keep progressing. And selling a repossessed development on is not easy. More often than not unfinished developments end up having to be auctioned and the value is massacred.
This is particularly relevant for bridging lenders providing development finance. Funding lines designed to pay investors a return linked to a monthly rate between 1-2% generated on a bridge just don’t make sense for development finance. The sums don’t add up. Developments take a lot longer than refurbishments and if a developer is paying 15% in interest a year it will consume profit even on the very best projects.
Lenders considering development finance really need to have arranged a separate funding line with lower costs to reflect the longer duration of projects. Currently I’m not sure there’s a huge number of funding options out there that we think make commercial sense. And given our background in development it is something we keep our eye on quite closely. The scales are certainly beginning to tip as the property market recovery strengthens and confidence is returning. But I would argue that we’re still not quite there yet.
Instead I am concerned that this increasing interest in development finance is indicative of something else – lenders with cash to lend are struggling to find deals they would do at the lower risk end of the scale. There is intense competition for every good quality bridging loan and even at the start of this year we’ve seen another big lender launch into the short-term market.
Bridging always was and remains a niche type of lending. Although the market has undoubtedly grown over the past few years – I’m not sure whether the £2 billion touted by some is accurate but I would concede that it’s probably now in excess of £1 billion a year – there is a natural limit on this sort of business.
There are lenders with expertise in the development finance market out there and I have no doubt that there is good quality business available to be done at the right price. The risk is that, in a bid to lend, there are those with less experience taking developers’ pitches at face value.
A growing market is in all of our interests but I worry that there are too many sales oriented people driving decisions that should be made by those with practical lending experience.
Matthew Anderson is a director at Fincorp
