Banks’ facilities to the property sector can be divided into property investment loans and development loans.
Lending for investment is relatively straightforward. The property is valued and the lender lends a proportion of the figure produced by the professional valuer. The lender looks to lend where the rental income is more than sufficient to cover the anticipated interest. The lender looks for a reliable covenant in the tenant and may adjust the amount of the loan accordingly. Some allowance needs to be made for possible increases in interest rates.
Loans may be made on a reducing or ‘interest only’ basis with the latter the more common, particularly when the term of the loan is relatively short (such as 5 years). In such cases it is assumed that upon its maturity the loan will be simply refinanced by the same lender or another, or the property might be sold. With much longer term loans partial of full reductions might be possible over the period of the loan perhaps starting after the first rent review.
The dangers of investment loans were that the security property would reduce in value for some reason or that the interest rates would rise to levels where the rental income was insufficient to cover the interest due. It is quite common for the property to be held in a Special Purpose Vehicle (SPV)and in the absence of other assets, or a guarantee from a third party, the lender might face a loss and the expert banking witness’s job is to say whether the granting of the loan and its terms were reasonable and prudent.
Much more complicated and risky is the granting of loans for property development, being the financing of a site, the building costs, professional fees and interest due on a new building. Property development itself is a risky process – manufacturing in the open air! That being the case the lender takes a significant risk in the financing and experience and skill is required in dealing with such transactions.
Professional assistance is required in determining whether the scheme is viable and whether the project costs and timing are reasonable; and whether the building likely to be saleable or let for a sufficient amount. Once a loan is granted, the programme has to be professionally monitored with regular reports to the bank as stages are completed and funded. The risk to the lender is reduced if a pre-sale or pre-let can be arranged.
Different banks have different attitudes to risk but arriving at a suitable ‘risk to reward ratio’ that suits the bank and the developer is important. Normally, a bank will consider how much it wishes to be lending at the point when the building works are complete (GDV – gross development value). At that point the property’s value can be determined almost exactly but in the meantime, the bank has to rely on its appointed valuer’s estimate of the GDV and agree to lend up to a proportion of that figure in stages as the development progresses. How the loan figure is broken down between site costs, build costs and professional fees and interest rollup depends upon circumstances but generally it is advisable for a bank to insist upon the developer introducing its capital into the scheme at the outset and for the developer to be made to wait until completion before taking its profit.
In considering the developer or the individuals behind the company, a bank will look for a good track record in carrying out broadly comparable schemes and for a contractor with a good reputation; and for a satisfactory professional team. The property may be owned by a special purpose vehicle (SPV) and there might be no support from other ‘group’ companies or individual. Whether this non-recourse arrangement would be acceptable depends upon circumstances.