A critical tool in the planning of a property development is the ‘Development Appraisal’, which sets out the financials of the project. Although a good builder knows from experience that they can build for £xxx per sq. ft., the complexity of developments now means that contingencies, professional fees and timings need careful scrutiny.
It is certainly true that where development funding is needed a good quality Appraisal document is a pre-requisite and lenders will examine these forensically and challenge them.
A pivotal figure in the appraisal is the ‘Gross Development Value’ (GDV), which is basically a robust estimate of what the properties will sell for upon completion. Lenders use this as one of several measures to cap the level of their borrowing.
However, it has become increasingly common for a developer to decide to retain some or all of the properties upon completion as an investment. This may not be a deliberate strategy, it could be that the timing is not right for sale in the market or funding cannot be extended to wait upon a delayed sale.
There has been a spike in this activity in the last year and definitely a flurry in the last couple of months as developers fear releasing a property onto the market with the uncertainty of ‘Brexit’. We all know of course that with a multi-unit development the level at which the first properties sell will set the benchmark for the whole development.
So financial appraisals should also consider the exit to the funding being retention as an investment – and, spotting an opportunity, many specialist lenders have launched ‘Developer Exit to Let’ type loan products, enabling a developer to buy a property themselves and used alternative funding to repay the development debt. That has the important added benefit of enabling them to get on with their next project.
The challenge comes when properties are in an area (especially London) where the GDV of a property is disproportionately higher than the rental value. Investment lenders cap their loans based on debt servicing levels, so the deal is driven not by the GDV/LTV but by what income the property will generate.
I recently supported a developer who had an iconic building to convert and just needed the development funding to cover the build costs, As the property was already owned (and in the balance sheet at a very historic value) the project on paper was extremely profitable – on a ‘project profit’ basis.
However, she was minded to retain the properties as an investment and wanted that option. When we ran those numbers, using several lenders ‘Development Exit’ products the warning signs were already there; she would not be able to exit the funding using that option. As a ‘development for sale’ it worked but the rental values dragged down the exit funding levels.
As a longstanding developer client of mine says “anyone can build a house, it takes a good developer to sell it”. The market is not always kind – it is worth doing a double check when completing appraisals for development funding to think about the viability of alternative exits from the outset.