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Real Estate Finance Insights

Real Estate Finance Insights

A man

Costs and constraints in the construction industry are constantly rising, which is causing an increase in the number of contractors declaring bankruptcy, not to mention significant delays to the delivery of housing projects. As supply chains continue to face disruption and interest rates carry on increasing, Mike Feasey, Relationship Director at Secure Trust Bank Real Estate Finance explains why it is more important than ever for developers to engage with lenders in order to reduce the risks brought on by inflation.

In the construction sector, the effects of soaring prices and supply constraints are becoming more and more apparent. Amidst commodity shortages and logistical challenges associated with the war in Ukraine, and mounting production costs resulting from the surge in energy prices, developers are finding it much more difficult to source building materials.

Along with the expenses of labour and supplies, land values are also growing, making the outlays associated with development projects greater than we've seen in a long time. As a result, we're seeing a growth in contractor insolvencies and a situation where developers are struggling to source replacement contractors at the same cost. To illustrate the difficulties, The Gazette highlighted that in the 12 months ending Q3 2022, the construction industry had the highest number of new underlying company insolvencies (3,949).

Away from the supply chain itself, the cost of a typical loan facility is also increasing as lenders are forced to accommodate a number of increased fees themselves. A widely documented upsurge in interest rates is being compounded by the costs of raising liquidity and the pricing-in of the greater risk lenders perceive in today's market. And like every other business, the lenders' own overhead costs are escalating.

Yet, in spite of such a challenging landscape, support is available for developers provided they are willing to engage with lenders before any unrecoverable difficulties come to fruition.

How should a developer approach a lender in the event of a delay?

As with any effective partnership, transparency is key. After all, delay is not a new concept to lenders and will always be considered in the form of contingency when assessing any construction loan.

Key considerations to make when approaching a lender are: 

  1. Engaging with the lender at the earliest opportunity, especially if significant disruption has been identified. The lender will need time to find a solution, often with input from the bank's independent monitoring surveyor (IMS) and legal advisors, so the earlier the forewarning, the greater the chance of a solution.
  2. Be clear about whether the delay is being caused by a relevant or significant event. The lender will need to know whether the developer or architect has put something in writing to confirm and set out a 'fair and reasonable' request for an extension of time and whether that extension of time is deliverable.
  3. Be prepared to provide a detailed and revised timeline or cashflow as well as a solution to the issue in hand. Giving the lender as clear an understanding of the scale of the issue and what the potential resolutions are will always provide the best chance of the project overcoming its difficulties. Evidence that the project remains viable and that a feasible plan B is in place can go a long way too.

Naturally, there are numerous other factors. These range from the potential impact of an increase in loan costs, the availability of funds for cost overruns, and the possibility for a lending covenant breach - all of which a lender will be on hand to discuss during any dialogue about a project delay.

What measures are lenders putting in place to mitigate mounting risks?

Given the growing number of challenges faced by developers in the current climate, many will be conscious of the reliability of their lender to deliver and maintain loans. Lenders recognise the mounting risks they are susceptible too, which is why the following measures are increasing in prominence:

  1. Loans to developers rather than contractors, with fixed-price agreements between borrowers and contractors then helping to lower the risk of cost overruns.
  2. A requirement for lower overall leverage for property development finance to lower risk.
  3. A good level of contingency - ideally around 10% against core build cost - for all development appraisals.
  4. A full due diligence assessment of any main contractors' finances.
  5. Verification of the projected costs of construction to ensure developers are able to meet their contractual obligations. This may include an assessment of forecasted increases in material and labour costs.
  6. A staged drawdown structure that ensures funds are being used for their intended construction purposes and not to cover unanticipated increases elsewhere in the project. While strict deadlines and site inspections may seem daunting to some, a lender's insistence on both of these will ensure funds are focused on the successful progression of a development.

Talk to your lenders as early as possible

While the lender will always maintain certain rights around the loan to mitigate risk, most respectable real estate finance lenders operating in the current climate are looking to aid the delivery of new homes.

In such a challenging and uncertain landscape, speed of action can prove vital. Those developers experiencing unforeseen delays should engage with their lender at the earliest opportunity with an open and honest assessment. Through effective management of risk and an understanding of a developer's current situation, lenders will often be able to ensure a project can still remain on course to complete.

For more information see our property development finance options.

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