The pitfalls of choosing the wrong non bank lender
Property developers undertake extensive due diligence before buying land or choosing a builder to partner with. However, they don’t always take the same care when choosing a lender.
While the vast majority of lenders in the non bank market are professional and honest - some are quite the opposite. Choosing one of these lenders can be a costly mistake.
To help borrowers avoid these lenders and protect themselves (and their projects), we’ve taken a closer look at some of the pitfalls and provided a few tips on avoiding these mistakes and partnering with the right lender.
Loan term shorter than the build program
Some lenders set the term of the loan shorter than the expected build program, which can result in the loan expiring prior to project completion. The lender then has the ability to charge a higher interest rate and fees for an extension or alternatively put the loan into default, knowing other lenders will be reluctant to take over an unfinished project.
To avoid this, developers should ensure the loan term provided by your lender allows plenty of time for your construction programme - plus a buffer in case of delays.
Unachievable sales milestones
When a lender structures an offer with sales milestones it’s important that the milestones are achievable. This is particularly pertinent in the current environment where sales are difficult to achieve. Not meeting such milestones can result in a default situation, penalty interest rates and halt access to progress payments, causing cash flow problems for both developers and their construction partners.
To avoid this, developers should start with a robust conversation with their elected sales agent to understand what an achievable milestone sales schedule looks like and if the lender's proposed schedule is achievable.
In addition, a developer should ask the lender “how do you usually respond to a missed sales milestone” if the answer is declaring an immediate event of default then this represents a potential critical risk to the project which should be fully considered before signing a loan offer.
An approach that may suit both parties is a stepped up interest rate structure where if a sales milestone is missed then the interest rate increases by a pre-agreed margin until the sales milestones are back on track. This approach acknowledges the additional risk to the lender while also incentivising the developer by imposing a financial penalty and opportunity to remedy.
Hidden costs
Lenders can use many different forms of pricing including a myriad of interest rate and fee structures which may not be fully itemised in the letter of offer.
Developers should always have a clear understanding of all finance costs so that they can accurately forecast the cost of capital as this is a critical component when assessing the profit margin of a project.
Onerous conditions
Some lenders set conditions that are near impossible to achieve. This could include the requirement that the borrower achieves an unrealistic level of presales prior to the availability of funds.
Before entering into any finance arrangement borrowers should fully understand these conditions and ensure that they’re reasonable and achievable.
Work fees where situations change
It’s common practice for lenders to charge a work fee that is payable when the borrower signs the indicative finance proposal. This fee secures the financial cost of the lenders time in the event a formal offer is provided and the borrower decides to go elsewhere.
There are lenders who charge a work fee and subsequently their financial capacity to complete a transaction changes. The lender will then withdraw their offer citing a technicality in the terms of the proposal and retain the work fee.
To avoid this it's important to only work with reputable lenders and ensure that you fully understand the terms of the indicative finance proposal before signing.
Capacity to fund
Many non bank operators may appear to be lenders with balance sheet capacity but in fact need to go to the market and raise investor capital to fund your transaction. In such a situation they are effectively acting as an intermediary when the debt will sit on a third party's balance sheet. The requirement of a lender to raise funds adds an additional layer of complexity which can cause delays in accessing funds for your project.
Another potential risk with this structure is that the third party ultimately calls the shots from behind the scenes. The third party may be based offshore and be influenced by global headwinds resulting in a heavy handed approach to managing the repayment timeline of your loan. This may be challenging if the development doesn’t go to plan and you require additional time.
To avoid this, borrowers should always understand the source of funding, who’s balance sheet the debt sits on, and who is the ultimate mortgagee and decision maker.
How to choose a lender you can trust
The vast majority of non bank lenders are honest and professional, but not all. That means borrowers have to do their due diligence and carefully select a funding partner (or risk problems like those listed above).
First and foremost developers should only borrow from companies with a track record of successfully delivering funding. Check their social media, speak to their past clients, and the lenders themselves to find out more about what they’ve done. Next, look for lenders with experience in the industry - preferably someone with a reputation to uphold. Check the director’s LinkedIn profiles and past positions to get an idea of their standing in the market.
If you’re looking for a funding partner - start your research by checking out Fortis Capital - one of New Zealand’s leading non bank lenders specialising in property development. Fortis Capital is powered by property people, including ex-senior staff members at major banks.