News & Views

Fincorp thinks: Is the vogue for development a warning the market is overheating?

By Matthew Anderson, director, Fincorp

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.

Bridging is all about good relationships:

Fincorp director Nigel Alexander believes bridging is all about good relationships and knowing what lenders want before you submit a deal.

1. What sort of deals should brokers consider Fincorp for?

Our bread and butter loans are short-term light refurbishment deals but we do look at heavy refurb as well. We do a lot of business funding developers who buy properties at auction and need finance at the drop of a hat. Bridging lenders all say they provide finance fast – we put our money where are mouths are. Brokers and developers have direct access to speak to directors at Fincorp and that means decisions are made on the spot. If a deal stacks up, we’ll do it.

We aren’t currently regulated so all of the business we do is unregulated. Within that we focus on first and second charge bridging loans on residential properties in London and the South East. We also lend as far down as Brighton and as far West as Bristol and Bath.

The minimum loan size we’ll look at is £100,000 but to be honest we do most of our business on loans much larger than this. We’ve done the odd one or two over our official maximum of £5 million and because we’re funded directly by investors we have long-standing relationships with, they trust us to advise them when deals make sense. That gives us a flexibility to look at deals that might not fit the traditional mould.

2. When a broker is trying out a new lender what three things would you recommend they try to have up front when they come to you with a deal?

Without a doubt brokers should have full details of the property and of the borrower. We want to know the property is what and where the borrower says it is, that all charges against it are disclosed and that the title is properly registered.

The borrower also has to check out and have gone through all the requisite anti-money laundering checks. A lot of the developers we deal with are professionals so we have confidence they know what they’re doing – that experience is even more important when we’re looking at a heavy refurb deal because the deal can be a success or failure depending on how long it takes to do. If someone is coming into a tough project with little or no experience that can be a warning sign to us.

The third thing that is critical is having a satisfactory repayment strategy in place. In the past bridging lenders used to accept the sale of the property as the exit strategy. Now we want to see that once the development has been done the borrower could remortgage onto a buy-to-let for example in case the property isn’t sold straight away.

3. What makes a broker good?

Bridging is all about relationships at the end of the day so rather than a broker being good at their job or a lender being good, it’s more a case of working together really well. Ultimately that boils down to the lender and the broker listening to each other. Borrowers want a bridging loan usually because they need a bridging loan. And they need it ultimately because it’s quick. Banks are still taking months and months to arrange finance and bridging fills that gap period – but it relies on being fast. Speed comes down to brokers accurately anticipating what the lender needs; it comes back to making sure you have all the right documentation in the right order, that you know who the borrower is and that the property details check out under scrutiny.

More important than knowing what the lender needs is probably knowing what the lender doesn’t want though. Being able to deliver funds fast comes down to wasting as little time as possible and for that we rely on our brokers not to submit cases that are just no-goes from the off. Different lenders in the market have varying appetites for different kinds of loans – being a broker worth his or her salt is often about understanding where to take what case so that loans get done quickly.

4. Why do you choose to work with brokers rather than just developers?

This market relies on brokers to introduce business to lenders. Because it’s a very full marketplace with a lot of lenders, all offering slightly different things it can be a bit overwhelming for property professionals coming to it for the first time. Often they don’t even realise that bridging finance is an option for them – they are let down by their bank because it can’t deliver the funds in the timeframe they need it and they turn to their broker.

And as I’ve said already brokers can really smooth the process. They know how to present the case and what documentation is necessary and they can get that ready up front saving time for their clients and making sure we don’t waste time going back and forth on a case that isn’t going to stack up.

That said, we do work with developers directly as well, often because we’ve worked with them on a repeat basis over the years.

5.  How can brokers add value to a deal when working with you? In other words, what can they do for their client that makes things run as smoothly as possible?

Make sure all the paperwork is in order before you submit the case and impress on your client that the speed their case is dealt with depends almost completely on the competence and experience of their lawyers. In nearly every instance that deals suffer delays it’s because the paperwork gets stuck in legal. 

I would strongly recommend that brokers suggest to clients thinking about using bridging finance that they consider using a lawyer who understands and has experience of arranging this type of property finance. Otherwise a deal that might look possible in three days suddenly takes over a week to get wrapped up. We can release funds the day we hear about a deal if we’re happy with it – the problem nearly always comes because a solicitor who hasn’t come across bridging before holds the whole thing up.

6. What should brokers be asking lenders when they take a bridging deal to them?

One of my biggest bugbears is that the cost of bridging is presented by different lenders in completely inconsistent ways. Some lenders charge fees at various stages of the process and build in kickbacks to their valuation and legal fees pushing these costs up for the client. They advertise headline rates that they don’t necessarily deliver and even if they do agree a low monthly rate, the additional cost that racks up through arrangement fees and extension fees, not to mention compounding and complex interest charges means the borrower still ends up paying. At Fincorp we believe in being straightforward and up front about what we charge. Ours is a single, flat rate monthly percentage. Nothing hidden in the small print. We charge no arrangement, redemption, exit or extension fees in a market that typically still does. We also pay our brokers a healthy introductory fee directly from our balance sheet – not the client’s loan - on completion of the deal.