The obvious and most important thing a credit team looks for when lending to a property developer is whether full repayment will be achievable from the completed property(ies) and, whilst there is always a risk of loss when lending money, there are a variety of ways a credit team will look to mitigate that risk.
Firstly, they will want to be satisfied with the experience, track record and capability of the developer and the key professionals employed, e.g. the main contractor, architect and structural engineer. Have similar projects been successfully completed previously, i.e. to budget and on time, and what was the quality of the end product. Secondly, location, location, location. What are the supply and demand dynamics in the local area, what's the size of the market and the current level of activity for similar properties, and how many other developments are underway which could impact demand for their project.
The credit team will expect the developer to provide a full project appraisal including specification, detailed costings and detailed planning permission. In addition to undertaking their own due diligence, a credit team will also usually require an independent valuer and monitoring surveyor to be appointed to verify the developer's expectations.
There will also be internal credit risk appetite parameters, e.g. a maximum loan to cost and maximum loan to gross development value and the credit team will require the developer's loan request to fall within this appetite. This will mean a certain level of cash contribution will be required to be injected and the credit team will also want to be satisfied that there is still sufficient liquidity to cover any cost overruns. And the credit team will also want to mitigate the credit risk by obtaining suitable security which would usually include a first charge over the site and, where the developer is a company, additionally a mortgage debenture and personal guarantee from the key shareholders.
Satisfaction with what we've covered above will have enabled credit to approve and drawdown the initial lend. Just as important for a credit team is that the borrower keeps the lender up to date as the build progresses. Regular site visits by the lender and often by the independent monitoring surveyor (IMS) will be required to effectively monitor the ongoing progress to enable early identification should any aspect be going off track. Development loan staged drawdowns will typically be subject to satisfactory IMS certification. Credit will expect the developer to highlight early if there are any problems and should this happen the credit team will be considering how best to support the developer address these to enable the build to be completed.
Finally, the development is complete, and a credit team will require the developer to have an effective marketing strategy which will vary depending on location as well as the nature and value of the property(ies). It will be important to be flexible dependent on the level of interest shown and firm offers made with pricing strategy amended if appropriate to enable the sales to complete, borrowing to be repaid and for the developer to achieve their planned profit.
Following a successful project, a credit team will then be looking forward to supporting the developer with the next development.
Richard Hendry, Head of Credit
Invest & Fund