Drawing a Development Loan

Property Development Finance reads a proposal: the feasibility backwards, who puts money in first, the presales, the developer, the exit. All of that is decided before a spade goes in. What it cannot decide is the next sixteen months, and on a development loan the next sixteen months are where the money is lost — to costs that rise, a builder that fails, a programme that slips past the dates the buyers signed up to. A development loan is therefore drawn one certified step at a time, and each step is a small credit decision in its own right. This page is the construction period, month by month, from the lender's side; the development loan file covers the product's anatomy.

The lender funds nothing until the build is pinned down, and the list of conditions precedent is where that happens. A signed building contract, with a price, a programme and a builder the lender's surveyor accepts — Issue 08's file arrived with the builder's tender, not a contract, which is the first thing a lender would want changed. The type of contract matters: a fixed-price contract puts most cost risk on the builder, a cost-plus contract leaves it with the developer and therefore with the lender. Consents in hand. Insurances with the lender noted. The developer's equity spent first and evidenced, because the lender's money goes in after the owner's, never beside it.

And the documents that decide what happens if something goes wrong: the mortgage over the site, a general security agreement over the development company, often guarantees, and a side deed with the builder that lets the lender step in and keep the building contract alive if the developer defaults. Issue 08's file lists that deed among the conditions. None of it is paperwork for its own sake; each document is an answer to a question the build will ask later.

The quantity surveyor is the lender's eyes on site. The lender funds against the certificate, not the claim, and the certificate says two things at once: what has been built, and what building the rest will cost. The second is the one that matters. The cost-to-complete test — the project is “in balance” when the money still available covers the money still needed — is run at every drawdown, and the day it fails is the day funding stops until the developer fills the gap. Because interest is capitalised from the interest reserve, the loan rises every month with the building and reaches its peak just before the first settlements, which is the moment the lender is most exposed.

A retention is the share of each certified claim held back from the builder until the work is complete and its defects are fixed. It protects the project against a builder who leaves defects behind, and the lender tracks it as cost still to be paid, because it will be. A variation is a change to the work after the contract is signed — a different finish, a design change, a problem found in the ground. Each one has a price and a time, and the lender wants to approve those above a set size before they are agreed, because an unapproved variation is an overrun the developer chose.

The contingency is what absorbs both, and every cost surprise besides. It is the only cushion between an ordinary overrun and a stalled site, which is why the lender reads it as a share of the build and asks what it has to cover. Issue 08's contingency is 3.5% of build cost against the 5–10% its file quotes as the norm, and the file's product page works out that a 5% overrun would exceed it on its own. A contingency that thin is not a saving; it is the developer promising that nothing will go wrong for sixteen months.

The largest risk in the construction period after cost is the builder. Builders run on thin margins and on each other's cash, and a builder in trouble on another job can stop this one. When a builder fails mid-build, the site stops; a replacement has to be found, priced and mobilised; the new price is usually higher; and every month of delay eats the interest reserve and moves the project closer to the dates its buyers signed up to. The lender's protection is in what it asked for before the first drawdown: a builder its surveyor accepted, a side deed that lets it step in, retentions that have not been paid away, and a contingency with room in it.

So a development lender reads the builder as well as the developer. Issue 08's file asks for the builder's accounts and current workload before construction starts — a builder with a healthy balance sheet and a full order book of similar jobs is one thing, a builder stretched across more projects than its balance sheet can carry is another, whatever its tender price.

Presales are the first way out of a development loan, and they are not settled while the building goes up; they are contracts, and contracts can fail. Two things decide whether they hold. The buyers' deposits, usually held in trust until settlement, which are what a buyer loses by walking away. And the sunset date in each contract — the date by which the units must be finished and titled, after which the buyer, and sometimes the developer, can cancel. In a rising market a late project keeps its buyers; in a falling one, a buyer whose unit is now worth less than the contract price has every reason to use the clause. Issue 08's suburb median fell 4% in six months, which is exactly the market in which a slipped programme turns presales back into stock. The lender reads the sunset dates against the building programme at every drawdown, and a delay that approaches them is a conversation, not a footnote.

Practical completion is not repayment. After it come the completion certificate from the local authority — a code compliance certificate in New Zealand — the issue of titles, and the settlements, each of which takes time the loan is still accruing interest through; that is why Issue 08's requested term runs past its sixteen-month build. As each unit settles, the lender releases its mortgage over that unit in return for a set amount of the proceeds: the release price. It is set above the unit's proportional share of the debt, so that the loan is repaid before the last units are sold and the lender is not left holding the least attractive stock. Some lenders go further, as the policy in Issue 08's file does, and take the whole net proceeds of every settlement until the loan is repaid. Either way, a developer who wants to discount the last units needs the lender's agreement if the net proceeds fall short of what the loan requires.

Whatever has not sold by the end becomes residual stock, and the loan against it becomes a different conversation: a term extension, a residual stock facility at a lower amount, or a price cut to clear. The lender would rather have that conversation early, while the building is still going up and the unsold units are still a sales problem rather than a debt one.

Sign the building contract before the lender asks, with a builder whose accounts you would show anyone. Put a contingency in the budget that covers the build you have actually had, not the one you hope for. Agree a variation process with the lender before the first variation. Send the QS certificate, the updated cost to complete and the sales position together every month, so the lender never has to reconcile them itself. Track the sunset dates against the programme and say so when they converge. And discuss release prices when the loan is written, not when you want to discount the last three units. A developer who runs the build this way is one the lender will fund again, which in development lending is the only relationship worth having. The developer's chair on Issue 08 reads the same file from your side.