The Developer’s Pre-Lending Toolkit – 7 Things Every Developer Should Know

The credit market is a highly competitive one and developers seeking construction funding are spoilt for choice.  However, the current economic climate has led lenders to become increasingly selective about the construction projects which they are willing to fund.

This means that developers should be well prepared before approaching potential lenders in order to give themselves the best chance of securing funding on competitive terms.  In particular, before speaking with potential lenders, developers should make sure that they have addressed the following key issues.

1. Know your own financial position

A lender will want to understand the financial strength of both the development entity and the key stakeholders, including directors, guarantors, sponsors and related entities.

A lender will want to see:

• Up to date personal and corporate financial statements and tax information of the developer and key stakeholders;
• The developer’s track record of delivering projects successfully and profitably;
• Evidence that the developer has sufficient cashflow to support the project and any cost overruns; and
• A clear picture of the developer’s existing debt exposure.

The developer should disclose to the lender any issues it has with its financial position, for example, a tax debt or a previous project default.  It is better for the developer to raise these issues at the outset rather than waiting for them to come to light later during the lender’s due diligence.

2. Get your project feasibility right

A lender will closely review the developer’s project feasibility.   This means that the numbers in the developer’s project feasibility must stack up and address:

• The total development costs (including contingencies); and
• The assumptions made by the developer about the project’s revenue.

The project feasibility must also contain a realistic project timeline which factors in planning, construction and presales timeframes.

3. Understand your equity contribution

Most lenders require the developer to make an equity contribution.  And it is common for lenders to require this equity contribution as a condition precedent to the first draw down of funds.  As a result, a developer should think carefully about:

• How much cash equity it can contribute to the project (as distinct from land equity alone); and
• Whether it will need additional funding (for example, mezzanine debt) to fund its equity contribution.

If the developer needs mezzanine debt in order to provide its equity contribution, then it will need to obtain the consent of the senior debt provider.  The senior debt provider, as a condition of its consent to the mezzanine debt, is likely to require a deed of priority.  This will add an extra layer of complexity and delay to the transaction which the developer will need to factor in.

4. Pre-sales and pre-leases

For residential projects, lenders will typically require a minimum level of pre-sales before committing funding to the project.  For commercial or mixed – use projects, the lender will assess the strength of the anchor tenant agreements, lease terms and enforceability.

A developer will significantly strengthen its negotiating position with a lender, if it obtains strong pre-sale numbers or pre-lease commitments before it approaches a lender.  Therefore, a developer should start its pre-sales or pre-leasing strategy early.

5.  Pick the right type of funder

The Australian construction finance market encompasses a broad range of providers, including:

• Major banks;
• Non-bank lenders; and
• Private credit funds.

Each category of lender has a different risk appetite, pricing expectations and asset preferences.  For example, a major bank may prioritise lower risk with experienced sponsors and strong pre-sales.  A non-bank lender may consider more complex opportunities, but at a higher cost of capital.

Understanding which lender best fits a project can save a developer time and improve its chance of a successful outcome.  It may be helpful for the developer to engage an experienced finance broker who understands the market.

6. Be ready for the due diligence process

Once a lender is interested in funding the project, it will start its due diligence process.  If the developer is prepared for the lender’s due diligence process, then this will help avoid any unnecessary delays.

The developer should expect the lender to request copies of title searches, planning approvals, construction contracts, quantity surveyor’s reports, corporate structure documents (including trust deeds), environmental reports and evidence of insurance.

7. Understand the risks that lenders focus on

Risk is a central factor for lenders in assessing any project.   While each lender will have its own risk assessment framework, the following risks will attract its particular attention:

• Construction risk – will the project be delivered on time and within budget and what is the quality of the builder?
• Cost overrun risk – are the contingencies and equity buffers sufficient to absorb any cost overruns?
• Market risk – will the project achieve the required pre-sales or pre-lease levels?
• Planning and approval risk – have all approvals been obtained and are they unconditional?
• Sponsor risk – does the developer have the experience and resources to deliver the project?

Conclusion

Preparation is key.  Developers who take the time to prepare detailed feasibility studies, organise their project documentation, understand what lenders are looking for, and address potential risks up front, will be in a better position to obtain funding on favourable terms.