In the 13 years since the global financial crisis, there’s been a dramatic change in property finance partners. Where once banks acted as the default development finance lenders, their risk appetite – particularly on the SME end of the market – has virtually evaporated.
Enter: private capital lenders.
Private capital lenders cover every end of the development spectrum – from bridge loans to large-scale structured finance. Although they’re not banks, they often take a traditional, bank-like approach to assessing risk and allocating capital. And this creates a complex landscape for residential developers to navigate.
Let’s demystify that landscape. Here are 5 big differences between traditional development finance lenders and progressive funding partners, with examples of how the varied approaches affect the SME end of the residential market.
Difference 1: Flexibility
The real estate industry is idiosyncratic. Every scheme is different, which means every funding package needs to be different, too. SME developers often encounter difficulties because traditional development finance lenders follow rigid processes when it comes to approving a deal and allocating funding. The outcome of this approach is that strong projects can often slip through the cracks if they don’t tick the right boxes.
SMEs can also find the process of securing financing complicated. Why? Because it can place a great deal of responsibility on the developer when it comes to structuring the capital stack. When working with traditional lenders, developers must not only be experts at identifying sites and driving projects forward. You must also be an expert in assembling the senior, mezzanine and equity packages, managing due diligence and negotiating the associated intercreditor agreements.
Progressive property finance partners take a more flexible approach. As a result, the approval process isn’t about sending a term sheet and then going through a tick-box exercise. Rather, it’s about looking at the nuances of an individual opportunity and assessing it on its merits. Because a progressive property finance partner does this deeper analysis, there’s less onus on the developer to drive the process. There’s also more flexibility in structuring the deal – across terms, pricing and capital allocated. That way, you’re more likely to get a package that meets your needs.
Difference 2: Risk appetite
This is related to flexibility but is an important difference in its own right. After the financial crisis, governments passed legislation limiting banks’ ability to undertake riskier, speculative lending. The old approach of going to the local high street bank and discussing a project with the manager disappeared.
While these new regulations were necessary to stabilise the global economy at the time, an enduring effect is that many SME developers now struggle to secure financing for projects with higher loan-to-value ratios.
Anything much over the 50% LTV mark is more complicated and poses more risk. Therefore, many traditional development finance lenders can’t – or won’t – finance these projects. Progressive funding partners aren’t restricted in this way. This means they have more appetite for taking on higher LTV projects, thereby broadening access to development finance.
A quick story: Traditional lender leaves a developer with a 77% funding shortfall
An SME developer in South East England spent more than a year trying to piece together their senior and mezzanine financing. They finally got pre-approvals “subject to decision making and underwriting” and then spent 6 months going back and forth over due diligence, intercreditor agreements and legals. At the end of the negotiations, the mezzanine lender sent its formal offer. The developer had a shock, because the lender only agreed to fund 23% of what they had asked for. “Subject to decision making and underwriting” meant a 77% shortfall.
To add insult to injury, the senior lender pulled out because they were taking too long to get the mezzanine piece sorted. After a year of work, the developers were back where they started.
Then they found Hilltop. We’re all property people, so we immediately saw it was a great location and a deal with great potential. We’re a small team, so there were no tedious layers of decision making. After a productive meeting with the developers and a detailed review of the opportunity, we agreed to fund the entire stack. The deal was completed, and the project is now underway. Without our ability to see through to the project’s true value, this high-quality housing wouldn’t be being built.
Difference 3: Speed
The more players and moving parts you have in your capital stack, the longer it takes to finalise the deal. Working with different development finance lenders for senior, mezzanine and equity requires months of meetings and negotiations – and seemingly endless paperwork. We routinely speak to developers who have spent 6 to 8 months dealing with the hassle of intercreditor agreements, only to have the whole thing fall apart because one party pulls out.
Progressive funding partners can deliver your entire stack. One set of documents, one set of surveys and valuations and zero intercreditor agreements. As a result, you can find yourself fully funded in weeks instead of months (or not at all).
A quick story: An SME developer gets fully funded in 8 weeks
An SME developer in East Anglia had an excellent track record and was trying to get a 100-unit scheme off the ground. Their senior deal was in place, but they were struggling to find the mezzanine piece. For 7 months, they accumulated term sheets and waded through multiple intercreditor agreements, surveys and legals. Every lender they spoke to ultimately pulled out. It reached the point where the senior lender was losing its appetite for the deal.
Then they came to Hilltop. We took over the entire capital stack, and they were fully funded within 8 working weeks – we committed at the beginning of December and they were up and running by early February (with everyone able to enjoy a Christmas holiday in the middle). The simplicity of having a one-stop funding solution meant the deal was done and dusted quickly.
Difference 4: Cost
In theory, using individual traditional lenders for senior, mezzanine and equity makes sense. The thinking is that you should be able to drive down rates at each stage. In reality, however, putting together the capital stack can be costly. With more lenders, you have more fees – arrangement, valuation and legal, to name but a few. At the end of all that accumulated cost, you as the borrower rarely come out on top.
There’s also an opportunity cost associated with the process of securing the property development finance. It’s not unusual to spend nearly a year going back and forth between lenders to negotiate intercreditor agreements. That’s time not spent securing the site and driving the project forward to get a return.
When you use a progressive funding partner for your entire capital stack, you eliminate those excess fees. And because you can move fast, you minimise the risk of losing out on a site – and can more quickly start generating value from the scheme.
Difference 5: Partnership approach
When financing the development involves multiple traditional lenders, each is only responsible for one aspect of the deal. This means that lenders only focus on getting the return for their specific element. A senior lender will typically go up to 60 to 70% LTV, which insulates them from any issues or market fluctuations that occur as the project progresses. Regardless of what happens, they get their money back. Risk trickles down the chain, which means the developer ends up taking the hit.
A one-stop progressive lender that goes up to 90% takes on more risk. This means they truly invest in the project’s success. As a result, they typically do more work at the beginning of the process to make sure the deal is as strong as it can be. It’s not about closing for the sake of it; it’s about structuring a package that delivers success. This partnership approach also means that if something goes wrong at any point, they sit around the table with you to find a solution.
Your property finance partner should help you seize opportunities
Ultimately, progressive funding partners offer a vast range of benefits for SME residential property developers when compared with traditional development finance lenders:
- Their flexibility means they delve into the nuances of the opportunity instead of following a tick-box approval process
- A greater appetite for risk means they’re open to higher LTV deals traditional lenders often shy away from
- They can act quickly – you can be fully funded in weeks instead of months and years
- The financing process is more cost-effective because a one-stop partner means fewer fees and less time wasted going back and forth
- Because they take on more risk, they’re more invested in the entire project’s success – making them a true partner in their approach
As a result, progressive property finance partners can help save time, energy and money as they simplify the private capital lending process for SME developers.
Learn more about seizing initiative in the residential property market – download our UK Residential Market Report 2021.