Four Common Funding Pitfalls for SME Residential Developers
For SME developers, securing funding has been needlessly frustrating, time-consuming and expensive for too long. I often speak to an exasperated developer who’s spent 6 months managing hundreds of emails, sitting through hours of meetings and has nothing to show for it.
The funding process doesn’t need to be like this. With robust government housebuilding targets and an alternative lending wave, SME developers should be able to move quickly. Avoiding these 4 pitfalls will help you manage costs, seize opportunities and drive projects forward.
1. Not presenting a credible deal memo to funders
Many SME developers prepare a rough development appraisal spreadsheet and send it to the lender. Within 36 hours they get an indicative term sheet, excitement mounts…and then the questions start.
To put together the funding package and provide actual terms, the lender needs more detail, which means there’s endless back and forth as everyone pieces together the required information. Months can go by with little tangible progress. And after all that, the deal can fall apart if the numbers don’t add up.
If you prepare a credible deal memo upfront, the whole process is more efficient. This means presenting the full economics for the various pieces of financing, underwriting the market, providing comparables, outlining your exit strategy and including third-party back-up information.
Not all SME developers have the time or toolkit to do this themselves, so it’s worth looking for funders who will partner with you to prepare the memo. The right partner will do the underwriting and put the analysis together before you go to the investment committee. This maximises your chances of getting a firm offer within weeks – and gives all parties confidence the project can be delivered successfully.
2. Not underwriting the professional team
With the collapse of Carillion, contractor due diligence has been in the spotlight – and the risks apply to the SME end of the market, too.
Too many developers overlook this key step in the funding process. Check the professional team has both the balance sheet and experience to complete the project. Your lender will want evidence of this, and it can jeopardise the funding process (not to mention the entire project) if this underwriting isn’t in place.
3. Piecing together senior, mezzanine and equity funding separately
Securing 3 different sets of funding can seem like a cost-effective approach because you can theoretically drive down rates at each stage. But developers often underestimate the meetings, negotiations and documentation involved, as well as the specialist knowledge required to navigate the nuances of senior, mezzanine and equity. It’s actually very difficult to come out ahead once you’ve factored in the legal and time costs associated with coordinating 3 separate funding packages.
On deals of £20 million or less, it’s generally more cost effective to work with one provider, where you have one agreement for a single credit facility that covers all 3 stages. And it’s much faster, too – it can easily take 6 to 8 months to complete your deal using 3 funders, whereas it can be done in 6 to 8 weeks if you use the right one-stop shop.
4. Focusing exclusively on price
Indicative term sheets can be like broadband advertising. There’s an attention-grabbing headline rate, but most people aren’t eligible for it because of their specific situation. With broadband, it’s about your location or the state of the cables. With residential lending, it’s about the process of securing funding and the way packages are structured.
Look beyond the headline rates. Consider the time you’ll have to spend and the legal hoops you’ll have to jump through. All that comes with a cost that affects the project’s overall profitability.
Also consider your relationship with the lender and where their interest lies. If it’s a transactional relationship, you can find yourself under immense pressure down the line depending on how your project costs evolve and what your sales are like. If the lender’s returns are driven in part by profit share on the back end of the deal, you have a partner aligned to your exit strategy – and who will offer more support in line with market dynamics.
All these pitfalls can lead to overpaying
You need a deep analysis of the market demand, comparables, affordability and rental data to negotiate with investment committees. You need to ensure your supply chain can deliver. And you need to factor in the time and legal costs of coordinating with funders. Your costs can easily escalate if you don’t – and that can have a major impact on profitability.
Avoiding these 4 pitfalls will help you secure the right funding package at the right price – and will give you the support you need to deliver successful projects.
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