What Are The Risks Of Non-Bank Lending For Property Development Projects In Australia?
When it comes to property development financing, no project is without its risks to all parties involved. And yet, there are several key differences to the risks associated with non-bank lending vs. bank funding.
Just as the lenders are taking a risk by lending to your project, you are taking a risk by borrowing the money. If all goes smoothly, everyone should be happy at the end of the project, and everyone is paid their money.
It’s when things go wrong that you get to know the true character of the lender.
Will they work with you if there is a problem, or will they “take you to the cleaners”? Here are some important things to keep in mind, all of which can play a crucial role in protecting yourself in the event that a relationship goes south with a mortgage lender.
Default interest rate differential
This shouldn’t be greater than 5% when in default. A default interest rate larger than this is a warning sign that the lender may want you to go into default.
Events of default
Some lenders will lay traps in their documentation that make it very difficult to stay out of default. Any loan agreement needs to be closely reviewed by a solicitor before signing.
This needs to be in line with the requirement for funding. A construction project should be at least three months longer than the build time to allow for any delays.
Many factors that can cause delays are simply out of the developer’s control, and excessive default fees are a red flag that this may not be the appropriate solution.
Amount of interest allocated
Make sure there is sufficient interest allowance to cover the project plus some contingency. If the interest allowance runs out, the lender may need you to cover interest payments or go into default.
Overly complicated fee structure
It’s essential to understand all of the fees associated with your property development funding, and when they apply. If there are significant fees that are not easy to understand, this may be a red flag.
And finally, the only controls we really have over the dodgy and aggressive lenders in the market are reputational. Be vigilant about doing your research about a lender before committing to anything.
It’s worth noting at this point that MFEG has never once seen an occasion where a project that transpired within the contract and without significant defects, delays or other problems, didn’t at the very least pay the developer and lenders their money back.
A case study in mortgage lenders vs. banks
Two projects of similar size start around the same time. One is funded by a private lender (Project 1), the other is funded by a bank (Project 2). Both projects had mezzanine funding at the back end, with around 90% of TDC covered (which is very high - make no bones about it).
Both projects get delayed - the reasons for delays are not entirely relevant, but many factors can contribute to this.
Project 1 was delayed due to a mistake by the builder. It was completed on time but couldn’t get the council to sign off. The First Mortgage lender put the loan into default, and the developer had to pay hundreds of thousands of dollars in default costs. Eventually, the project was liquidated, and the developer lost their money.
Project 2 was delayed due to the unavailability of trades and slow progress with the council. However, the bank worked with the borrower and didn’t charge any default fees, with normal interest charged throughout. Delays reduced the profit somewhat, but with some positive movements in the market, the developer still made a reasonably healthy profit margin.
The difference between the two projects was the default rate and fees charged by the senior lender in Project 1, as well as the willingness to work with the developer.
The solicitor’s role in non-bank funding for property development projects in Australia
One other factor that doomed Project 1 was the developer’s refusal to engage a solicitor to act on their behalf. If you’re looking to borrow money privately, you should always get legal advice. A good lawyer will pick up unusual contract clauses and help you with the settlement process.
Private lending documents are often weighted heavily in favour of the lender, but can be open to negotiation. As with any big transaction, you should fully understand what you are signing before you sign it. Make an effort and ask questions.
Like anything in life, though, there needs to be a balance between caution and taking action. Being overly cautious on loan documents can cause delays and potentially scupper what may be a good deal for you.
There is also a cascading risk with the more money that you borrow. In general, the higher the amount you are borrowing, the more cautious you’ll need to be regarding the documentation you are signing, and the greater the need for legal advice.
Non-bank lenders in Australia – what’s the takeaway?
While banks are generally the cheaper avenue for property development funding, they are also more risk-averse, slower, they require high equity contribution from the borrower and they require the debt to be covered by pre-sales.
Non-bank lending may certainly be the more efficient and flexible option for your specific project, but remember to:
Always get legal advice before signing documents
Make sure you fully understand what you are signing (don’t just use your solicitor to witness documents). Understand that borrowing money inherently carries risk, so try to strike a balance between ensuring you are protected without consequently denying yourself a good deal
Speak to MFEG
MFEG specialises in assisting property developers to successfully fund their projects. We’ve established an exceptional track record in achieving excellent outcomes for our clients via First Mortgage, Mezzanine (Second Mortgage) or Preferred Equity, using our extensive panel of funders on a range of different borrowing scenarios.
For more information, get in touch.