What is Development Exit Finance? – Part 2
I introduced development exit finance in last week’s blog.
Essentially, when a developer completes a project, the houses or flats then go on the market for sale. But if, as is the case in the current economic climate, sales are slower than the developer would like, this can put enormous financial pressure on the developer.
This is because the finance that was raised to carry out the development, is often at a higher rate of interest, with the interest costs on the development finance being rolled up. If sales are delayed, this can end up ‘eating into profits’. In addition, the development loan is likely to be coming to the end of the term, be it 12, 15 or 18 months.
As a result, the lender who provided the property development finance starts to put the developer under pressure. They’re looking to be repaid, but the finished properties aren’t selling. One option of course, is that the developer drops the sale prices, but a reduction in prices of 10% to 15% won’t leave too much profit.
None of this is great news for a developer. So, what’s the solution?
One option is development exit finance.
In last week’s blog, I explained the advantages for you as a developer of using exit finance. This week I want to look at the lending criteria and the costs to put development exit finance in place.
Loan to value:
Usually this will be up to a maximum of 70% of the GDV (end value) of the completed development. However, see a further explanation of the maximum loan to value available below under the sub-heading: ‘interest rate’. The key point when arranging exit finance, is that it is normally used for two things. Firstly, to repay the existing development loan. And secondly to release capital ‘locked-up’ in the completed project, that a developer can then use to inject as cash into a new project.
Again, lenders vary when it comes to interest rate on exit finance, but an interest rate in the region of 6% – 7.5% is fairly common and is of course lower than the interest rate on development finance and much lower than the interest rate on any mezzanine finance that may have been taken out. The saving is therefore obvious, particularly if the sale of the completed project is taking longer than anticipated.
One point to note. As I mentioned above, the gross loan is equal to 70% of the GDV of the completed project. From this gross loan, the lender will deduct the interest costs for the period of the exit finance – usually 12 months. This leaves a net figure of circa. 65% which is usually more than sufficient to repay the senior debt on the development.
This is normally for a period of 12 months, which typically gives the developer more than enough time to ensure the completed project is sold. Of course, if the finished development is sold within the 12-month period, any interest deducted but not used during the 12-month term is credited back against the final redemption figure.
Expect to pay an arrangement fee on the exit finance facility of 1% – 2%. This is fairly typical but shop around and see which lender is offering the best deal. Alternatively, your broker will look at all the options on your behalf. Once your broker has reported back to you with what’s available, you can make an informed decision.
Typically, these are 0%. It is very unusual for lenders to charge either an exit fee of an early redemption charge on development exit finance. If they do, I would suggest looking at alternative lenders as you do not need to pay an exit fee on these types of loans.
The one important condition for a project to qualify for exit finance is it must have reached what is called practical completion. Although there is no standard definition of practical completion it is generally considered to be the point at which the building project is complete in accordance with the building contract and the developed property is fit for occupation. Normally a certificate of practical completion is issued, confirming planning permission and building regulations have been complied with, and this would be required by any lender considering development exit finance.
In addition, if it is a new build project, you will also need to have a build warranty such as an NHBC in place.
If you are considering exit finance, don’t leave it until your development has been completed before you start trying to arrange exit finance. Instead, put it in place beforehand.
Of course, the development will need to have been finished, and the local authority will need to have issued a completion certificate to confirm they are happy that all planning and building regulation requirements have been met.
However, there is nothing to stop you putting exit finance in place ahead of time, including having a valuation carried out. Then, as soon as you have a completion certificate, and the build warranty is in place, you can draw down on the exit finance and repay the development finance without any delays.
If you have a requirement for development finance or exit finance and you want to speak to an expert, gives us a call on 020 8949 2122 or email us at firstname.lastname@example.org