Continued from…
12 Things that property development lenders look for [Part 1-2]
7. The property development team
The capacity of in-house staff is crucial, as is the capacity of outside professionals.
Although outside professionals are typically less crucial than the developer because they can usually be replaced, doing so is always expensive and can compromise the project in many circumstances.
When one crucial professional is replaced with another, the project will suffer material harm, sometimes physical but always financial.
It can be challenging to evaluate the developer’s team, especially on smaller projects where experts are paid less, have less expertise, and have less comprehensive track records.
At the very least, the lender obtains résumés from the architect and the general contractor or construction manager, along with references.
He requests the names and résumés of the principal subcontractors on more critical deals. Major subcontractors nearly always include those who perform electrical, plumbing, masonry, superstructure, and carpentry work, depending on the job.
Architects always have résumés, references, and a track record that is immediately traceable.
Don’t try to fool a lender by a flashy brochure, which has become the norm in architecture.
For example, a developer might be impressed by a school building, an inventive gymnasium, a courtroom, or a retail centre designed by an architect.
However, he may be unaware of the design and construction of a hotel or office building and the services available.
In many sorts of constructions, size might be a problem. The type of project is a more crucial consideration when evaluating an architect’s relevant experience.
The developer must have some prior experience in the location where he’ll be building. For the architect, it is much more crucial.
Most building standards and requirements may be quickly looked up and integrated into development plans and specifications, but some aspects are virtually usually overlooked.
An architect who has made past mistakes and omissions on similar tasks is likely to know how to avoid making them on yours.
It is usually not a problem for larger architectural firms because they have the experience and resources to engage local professionals to supplement their in-house capabilities.
Smaller organizations, on the other hand, may never be completely aware of local standards, may be too thin on multiple projects, or may be searching for their subsequent work as soon as the one with the developer is through.
Because the architect may have to interact with local municipal personnel regularly if there are zoning, regulatory, construction, or legal issues, personal familiarity with local officials and employees can be a huge help in obtaining development approvals in the shortest time and for the least amount of money.
8. Construction manager or General contractor
Not only does the lender familiarize himself with the types, magnitude, and locations of projects performed by the general contractor or construction manager, but he should also make sure that at least one reference comes from the owner of a previous project.
It is nearly impossible to show that a contractor worked on a given task and, if he did, the extent of his involvement without consulting references.
Lender also contacted the inspecting engineer at his institution to check if he has any insights or knowledge about the prominent members of the building team.
Inspection engineers are an excellent source of team reviews because they review projects for a living.
Keep in mind that, while a lender is conducting your due diligence on the project’s team members, a skilled developer has likely done a better job because the team he assembles will work for him and report directly to him. There’s a lot on the line for him.
The developer has frequently worked with the general contractor or construction manager on previous projects and is familiar with most of the major subcontractors. As a result, he understands what to expect in terms of performance.
Lender is doing his due diligence after the developer is finished with his. It should provide the lender with some peace of mind, especially if he is looking at the credentials of a seasoned builder.
However, there are thousands of stories of incompetence in the construction sector, so doing some due research is always a good idea. Due diligence is critical when working with an inexperienced or smaller builder to safeguard your institution and career.
9. Financial resources
Even for a publicly traded corporation, determining financial capability is difficult.
It was especially evident in the early twenty-first century when officers of several publicly traded corporations were fined and sentenced to prison for misrepresenting their employers’ financial status.
Imagine how many smaller businesses are getting away with lying now if they could get away with it for so long. The biggest impediments to determining financial strength are inherent in the techniques employed.
Balance sheets or personal financial statements, for example, are snapshots of a corporation at a specific time.
Although income statements can demonstrate results yearly, cash flow, particularly in the real estate market, can vary greatly. The day after a loan closes, bank deposits can vanish.
In real estate, you nearly always have to rely on unaudited financial documents, which might be more fiction than fact, even when prepared by an accountant.
When banks or PD lenders assess a property developer’s financial capacity, they consider the following:
- Cash flow projections
- Liquidity
- Refinancing timing and impact
- Lease expirations and timing
- Receivables
- Paid
- Value
- Contingency
IMPORTANT
If you are a property development lender, you should be alert for the following:
- High net worth but low cash and working capital
- Cash Flow timing and quality
- Overstated property valuations
- Unlisted liabilities
- High leverage
Although evaluating the borrower’s total financial health is vital, you’ll be focusing more on his performance against the collateralised property; thus, you should adequately scale his financial strength. Due to unreliable financial projections, you shouldn’t rely on the developer’s net worth and cash flow as much as his equity.
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10. Equity
Capital call provisions are essential in partnership and operating agreements. Lenders want to know that at least one partner will invest if needed.
Property developers should be the main contributors because passive investors are hard to find. Inactive partners are usually requested for money late.
They need time to process the unpleasant news and gather the necessary funds. This delay can harm a financially troubled property development project.
If the lender thinks the developer may have trouble supplying additional unplanned equity, he can demand more significant equity while keeping the loan amount the same.
The additional equity can be invested into the project immediately, and he can assign more to the loan’s contingency budget to cover overruns.
This early control helps prevent building delays. Contingency funding must not run out before the project is finished.
Land as equity
Investors watch out for property developers who use land value as their sole or significant equity contribution. Borrowers often paid less for land and saw it appreciate over time.
Possession of land, even above the standard loan-to-value ratio, won’t guarantee the borrower has the cash to finish the project.
It won’t ensure his commitment in tough times. Many borrowers are less enthusiastic about investments made with land than with cash.
Intangible equity
It would be best if you also were wary of partners who don’t invest cash or whose money goes elsewhere. Deferred broker fees for property equity are typical.
The broker, now a partner, doesn’t invest any cash. He probably won’t invest real money if there’s a capital call.
Another red flag is a developer working with the same equity partner on multiple ventures. The equity partner may make further equity investments if needed. In this circumstance, the developer cannot repay the equity partner.
Instead, he provides the partner with a stake in the project. You may receive this equity partner’s impressive business financial statements during due diligence.
The partner, who wasn’t paid on his previous agreement, won’t invest in this one with the developer. If anything, he wants to recoup his last deal’s cash with the loan before making a profit.
Despite his net fortune and liquidity, he may delay or refuse to fund the initiative. You should know what exactly is equity finance and how does it work.
Developer’s personal capacity
Knowing the developer’s personality can prevent complications.
11. Health
Suppose the borrower has all of the right qualities, such as experience, money, and a good reputation, but has trouble getting around, talks in long rants about the past, does not appear to be fully present when spoken to, takes time to orient himself to questions, etc.
In that case, it may be possible that his health may have deteriorated to the point where he no longer can work on a project that will take two or more years to complete before repayment, and so on. It isn’t common, but it’s not unheard of either.
There is a propensity to fail to notice or overlook impairments, especially in the real estate market, where a significant majority of property developers are one-or two-person firms or are employed chiefly by family members.
Several well-known and accomplished developers have worked much past the point at which others might consider it appropriate to retire.
If the borrower’s health is questionable, it’s irresponsible to lend money without vetting his succession. Does he have a successor? Even if he appears in good health, it’s nice to know that a team can carry on if needed, at least until the matter can be reviewed and treated.
Note:
Lenders may not deny a loan request solely for health reasons. He is not a doctor; thus, his institution could be accused of prejudice.
If the borrower’s health represents a substantial concern in the loan analysis, he should consider utilizing other factors to refuse the loan.
If he feels the borrower’s health may be a concern but is rushed to close the deal, he should look for other ways to improve the credit. It may require a project manager, another team member, or more equity to reduce the loan-to-value ratio to offset the higher risk.
The developer’s performance is key to loan payback if the borrower isn’t healthy enough to finish the project and isn’t backed by others who can take over, don’t make the loan.
12. Character
It’s tough to assess a person’s positive and negative traits objectively. Character judgement is subjective. Lender or someone from his institution will have first-hand experience with the borrower if he already has a relationship with them.
Some general inquiries can be instructive.:
- Was the borrower pleasant to work with?
- Was he as good as he said he’d be?
- Was he responsive to information requests?
- Is he a problem-solver?
- Did he lead his group?
Because it is a human inclination to take positive features for granted while accentuating bad ones, if he is a new potential borrower, lenders are unlikely to notice favourable traits as much as potentially hazardous negative ones.
Character qualities are rarely used to deny a loan. Economic conditions can lead to a lender’s market or a mismatched borrower and lender.
In a strong market, the lender and his department may be at or near workload capacity; therefore, taking on demanding or tough borrowers may be counterproductive.
Depending on the lender’s management and reward programmes, you may have met or exceeded your financial goals (a period is almost always one year).
Booking more business, especially with a borrower he knows has a character problem, might cost him when a new period arrives and new financial targets are given.
Future ambitions are usually higher than earlier ones. To achieve goals in the following period, he may need to exceed them in the present.
When a borrower matches his loan request with the wrong type or size of the lending institution, but mitigating factors make the loan desirable, the character is often the decisive factor.
Note for lender:
If his loan is too big or too small for your institution’s “sweet spot,” you should undoubtedly turn him down if he has a character problem. Why fight for him if he’s beyond your institution’s mission? Save the fight for a good borrower.
Character labelling
Character labelling can prepare the lender for a rocky lender-borrower relationship. Personalize his response to the developer. Some borrower features to watch for:
- Greedy
- Cheap
- Difficult
- Egotistical
- Stubborn
- Unfocused
- Unable to expedite things
- Authority-rejecting
- Secretive
People are dynamic and developing, with complex personalities. Personal labels can assist build a framework for a conversation, but they can be harmful if misused or if they hinder flexible contact.
Be wary of labels and open to adjusting your mind as a relationship develops.
Most loan officers enjoy a deal. They see a completed project outline, the figures make sense, a property tour goes well, they like the borrower, and they’re impressed by his presentation.
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Bottom Line
So, what do property development lenders look for before funding a PD project? The list above provides a snapshot of the key items that are considered.
If you’re thinking about embarking on a PD project, it’s important to be aware of these factors and have your team in place early on so that you can present a strong case to potential financiers.
Successfully develop your first property, enroll now for Mastermind property development course.
FAQs
How do you ask for project funding?
The best way to ask for project funding is to be clear about what you need and how the money will be used. It’s also helpful to have a well-developed business plan and a track record of past successes.
When asking for project funding, it’s important to remember that you’re asking for someone else to invest in your idea.
This means that you need to make a strong case for why your project is worth funding and how it will benefit the person or company who provides the money.
Being concise, clear, and professional are all key when asking for project funding. And remember, always be prepared to answer any questions the person or bank may have about your proposal.
Can I get a mortgage for property development?
Yes, you can definitely get a mortgage for property development! However, the type of mortgage you’ll need will vary depending on what stage of construction your project is in.
If you’re still in the early stages of construction, you’ll likely need to take out a short-term loan or bridge financing. This type of loan covers the costs of getting your project off the ground until it’s ready for long-term financing.
Once construction is complete, you can then apply for a traditional long-term mortgage.
Mezzanine finance is another option if you’re looking to finance a property development project. This type of financing typically comes in the form of subordinated debt or equity.
What do funders look for in a loan proposal?
When it comes to lending money, there are a few things that all funders look for in a loan proposal.
The first and most important thing is that the person requesting the loan has a good credit score. This indicates that they are likely to be able to repay the loan on time.
Funders also look at the proposed interest rate and how long the loan will be for. They want to make sure that they are getting a good return on their investment, and that the loan is not too risky.
Lastly, funders look at what collateral is being offered in case of default. This could be anything from property to stocks and bonds.
