In this article, Mike Bristow, CEO of CrowdProperty, examines insights from our SME Property Developer survey - the largest ever undertaken in the sector with over 500 participants - to help you distinguish some of the factors you critically need to consider around the murky funding market.
On 30th June, Boris had his own “education, education, education” moment. “We will build, build, build… build back better, build back greener, build back faster.” An exciting rhetoric for anyone involved in building physical assets… but as always, the challenge is in the implementation. The sentiment is right – the principles of Keynesian economics, which advocate increased government expenditures and lower taxes to stimulate the demand-side of the economy, has proven itself in many economies in their toughest ebbs, especially if this can be mirrored by private sector investment.
So, who will build, build, build and play a key part in reviving the economy? Spoiler alert: if you’re an SME developer – we believe it’s you. Major infrastructure, such as HS2, is an obvious investment area - but this is the opportunity, and maybe the imperative, to finally build enough homes in this country, which is so vital in many regards for the economy. The secret to doing that is empowering the entrepreneurial SME residential property developer segment but as you’ll probably have felt, that needs the many barriers that have significantly increased over the last decade to be tackled.
We talk quite a bit about the remarkable decline in SME developer housing output (from c.60,000 homes in 2008 to c.20,000 in 2017, in a context where the country built only 200,000 in each of those years - considerably less than the 300,000 required) so for this segment to be the answer, not only do we need to significantly increase output but also reverse this declining trend – tackling the fundamental barriers that have been behind it.
The planning system has been a major barrier for SME property businesses building more homes in this country and significant changes are following Boris’ rhetoric. CrowdProperty's research, which includes the largest survey ever conducted amongst SME residential property developers to give this important segment a voice, shows that SME property professionals believe that 'an improved planning system' could be the third most beneficial driver of building more homes going forward, above ‘improved tax policies’ in fourth. These are only surpassed by 'an improving economy' (which is less directly influenceable) and 41% selecting 'better sources of funding' – now we get to the nub of the issue. So whilst the Government is pulling planning and taxation levers, building the best SME property project lender in the market was the genesis behind CrowdProperty - addressing the many pains associated with traditional sources of funding that have progressively choked this segment more and more over the last decade. There’s never a more powerful raison d’être for a business than solving fundamental market pains that the founders have felt personally and know how to solve.
The key things to consider in choosing your funding partner
So, let’s dig into some more of the survey insights that represent the underlying sentiment of SME developers, pre-Covid19 disruption.
A big change since I started investing in property in 2002 is that the not-so-sophisticated (albeit successful) strategy of ‘buy house, let it out, refinance, repeat’ that I employed doesn’t stack up anymore. Extraordinary profit attracts greater competition (and often taxation) and that requires participants to compete harder, to shift business models and generally need to work harder for profit. The strategy most preferred by respondents to our survey, with 62% stating they will be doing it ‘more’ (35%) or ‘much more’ (27%), is to build/refurb to keep. We see this as a structural change amongst property investors in the absence of strong capital growth projections – ‘buy, add value, refinance, repeat‘ – the value-add piece enabling recycling of capital being the change, the consistent piece being the desire to build a long-term portfolio, despite taxation changes for landlords.
Your peers then dug into the crux of the biggest housing output barrier responding to ‘What’s most important when seeking finance for your property projects?’ Top responses, i.e. the most important factors, amongst the entire set of respondents were:
Reliability of Finance
Speed of Finance
Loan Amount / Maximum LTV
Quick and Easy Drawdowns
Before digging into each of these in more detail, it’s powerful to understand differences between experience segments in the importance of these factors. Relative to the overall set, less experienced SME developers place greater importance on LTV, Interest Rate, Fees and Timing of Fees. This is rational – they are building cost models and working to optimise those to ensure that the development stacks up and can potentially raise equity investment to complement the debt capital. The telling factors are those which are rated relatively important by more experienced developers – they rate Reliability of Finance, Transparency, Speed of Finance, Quick and Easy Drawdowns, Access to Decision Makers and Knowledge/Expertise of the Lender highly – they have felt the pain of traditional sources of finance more (a very tangible example here is in speed of drawdowns – sitting on IMS reports can have severe knock-on effects to contractor moral and potentially project progress), and crave a better holistic, expertise-based, trusted partnership with their lender. Experienced developers know that reducing the time spent on funding (which for an SME developer is approximately one-third of their time) means that more time can be spent on finding sites and progressing sites – i.e. growing their property business quicker. It’s very powerful acting like the more experienced in your field and seeking those critical success factors yourself.
Let’s take a look at the factors that were collectively rated highest in more detail. What do they actually mean? First and foremost, it’s fascinating that in a pre-Covid19 world (the survey was Q4 2019), Reliability of Finance came out top. The reality is that this has never been more stress tested than through Covid19 lockdown. We collectively know a lot more about how reliable lenders are when the going gets uncertain and whose sources of funding are actually reliable. Understanding the sources of your lender’s capital is critically important – we’ve seen offers being reneged upon (not just tightened on LTV/LTGDV) and even drawdowns to cover completed activity on site being refused through no fault of the project itself (we’ve refinanced both situations in the last few months), which is destructive to the project. This is driven by the fact that many lenders have single sources of wholesale capital, whose broader exposure is often linked to equity markets. They will press pause when markets get volatile… which ultimately impacts you most of all. As it happens, and what couldn’t be more important right now, is that we have uniquely diverse sources of capital from retail, high net worth, ultra-high net worth, private fund and major institutional sources. Lenders with concentrated sources of capital were the first to shut up shop as Covid19 set in. Even those with multiple sources were exposed as those sources had exactly the same underpinning exposures to equity market volatility and lending attitudes. Diverse types of capital, with many sources within each type, with different needs, preferences and attitudes, which can only be built up from 6 years of lending with a perfect track record, gives far greater reliability of funding through any stage of market cycles.
Transparency in a devious market
Let’s talk about transparency. It’s important to recognise that commercial lending is not regulated by the FCA. If you’re embarking on a loan for a property project of any sort, and if you would like one single takeaway from this article, make sure you understand and model every element of the loan agreement, all clauses and run every scenario (without just the natural optimistic eyes that a property entrepreneur will bias towards). One of our most recent comparisons of our offer versus another major development lender for a borrower revealed a staggering difference in total cost of the loan despite an interest rate that was similar… and that was before late loan rates and fees were factored in when assessing outcome scenarios. Hidden fees are the epitome of opacity in a lending relationship… and the sign of a lender looking to monetise each and every loan rather than focusing on building a long-term, potentially career-long, partnership with a developer. The raft of hidden fees that we’ve racked lending offers for include (but are certainly not limited to):
Arrangement fees quoted as a ‘per annum’ %age (i.e. the fee is 50% more than at first sight for an 18-month project)
Exit fees as % of GDV (again could be 50% higher for a strong project)
Interest charged quarterly (1 day into the next quarter incurs 3 months additional interest)
Very high monitoring fees (in some cases almost enough to pay the entire salary of your monitoring surveyor)
Loan management fees (which is the lender’s job and factored into the arrangement fee / interest rate)
Penalty fees on top of penalty interest (more on penalty interest later)
Lender’s broker fee recharged (after your own broker fee too – this could all amount to 2-3% of the loan amount – it’s an expensive channel to find your loan, which you will end up paying for)
Whole facility rate charges (even when not drawn)
Many types of fees (we’ve seen ‘setup’, ‘admin’ and ‘management’ fees on the same offer)
Margins/kick-backs taken on professional fees (just a further failing of trust / transparency)
One of the most obvious (and easiest) areas for scrutiny is the penalty interest rate – applicable if you go beyond term on your development/bridging facility. In our survey, a quarter of respondents did not know the penalty rate of their current/last facility. The reason this is worrying is that of those that did know, 32% knew it was more than 2% per month and 18% knew it was over 3% per month. The further reason this is worrying is that the risk of incurring these is related to the term length relative to the complexity of the project and, more importantly, the attitude of the lender in setting that term length. Whilst we very much admire and support property entrepreneurs, we also look to temper their optimism where, for example, they may request a 12-month facility for a project that needs 16 months. We’ll push back and offer for 16 months to give breathing space, allowing them to pay back early at no cost and only pay interest for the time the loan is actually outstanding, rather than exploiting the high probability that a 12-month loan will end up incurring late fees/rates. Property projects are projects. Things will go wrong, so build in breathing space on your facility and be aware that, remarkably, some lenders have been known to incentivise their staff on loans that run late because of all this bunce. Nobody needs more stress in their lives, especially when already tackling on-site challenges.
You’re a professional taking a commercial loan – there is little protective recourse, so make sure you understand and model every term and think beyond the successful outcomes of the project. Ask yourself ‘what if?’.
We are building long-term relationships with our borrowers, changing the transactional, hidden-fees, ‘milk this loan’ game that plagues the property project lending market. That’s fundamentally why our borrowers keep returning to fund their next project with CrowdProperty – we’re a true, long-term funding partner and become a valued part of their team, adding value throughout their projects with our team’s hands-on, on the ground experience having been SME developers ourselves.
Obtaining your loan
Next, let’s go into some insights on obtaining your loan for your project. Around half of respondents apply for finance once an offer has been made on a site/property. Only 17% apply for finance when they’ve found the site and have run preliminary numbers, before they’ve started to negotiate. We believe that many are missing a trick here. We provide speed, ease and certainty of funding partly because vendors want speed and certainty. We have provided proof of backing letters to take into the negotiation, with spectacular results. We’ve had our customers save tens of thousands of pounds by putting forward a more advanced offer package to the vendor, including certainty of finance, versus the highest bid for the sites in question. Engage early and differentiate your offer from others – it’ll pay handsomely.
When we set up CrowdProperty, we believed that a direct relationship between developer and lender is critically important. This is not just efficient (this takes out considerable fees for both borrower and lender) but it enables the critical parties to work together to structure the best product, expert to expert, which endures as a partnership throughout the project. We again see this recognised by experienced developers in our survey with many preferring a direct relationship with their lender. We believe that our focus on working directly with you from start to finish is critically important, giving you the benefit of decades of development expertise, access to our decision makers and ultimately a lender that is a value-adding partner throughout the project as property people offering property finance. Costly broker fees (as discussed above) is the second most cited reason for working directly with lenders, especially if that’s extrapolated across every project you undertake, versus embedding a great, full-service development lender into your power team.
Our partnership approach has been brought into focus during the recent pandemic, where we worked closely with existing borrowers to advise on reviewing supply chains, identifying areas of potential impact, implementing new working practices/procedures and working closer than ever with them in many practical and knowledgeable ways to mitigate the risks to progressing their sites. With existing projects which have suffered delays, we are working on a one-to-one basis with developers, agreeing new terms with those whose loans have either ended or are about to end giving them comfort that they have new/extended loans, getting them off penalty positions, giving them plenty of exit runway which they can repay early at no cost and protecting their legal position, whilst ensuring our lenders’ position is safe. Equally, with our Development Exit and Development Finish and Exit products, we’ve refinanced developers away from lenders who have failed them. We recognise that working together always produces the best outcome for a project, sharing a common goal with our borrowers – to finish and exit the project successfully.
Just as SME businesses are the beating heart of the wider economy, empowering the multitude SME property development businesses is the secret to delivering 'build, build, build', finally delivering enough homes into the market and driving much-needed spend in the economy on labour, materials and services.
These insights, coupled with so many more from our research and crucially our own experiences as SME developers ourselves, have enabled us to build the best SME property project lender in the market. As property finance by property people, we’re bringing back customer focus to a market that has long forgotten that philosophy, changing the game of property project finance, very much open for business and here to help. Let’s get talking even if you haven’t got a project right now such that when the building frenzy starts, you’ve got the best of the best on your team. Together we build a better future.