New Funding Risks for Developers in the Current Market

New Funding Risks for Developers in the Current Market

Be one of the first to receive my upcoming

Simple Guide to Development Financing in Australia.

It will focus on issues developers' need to know to avoid costly mistakes.

It includes over 30 tips to improve your financing outcomes.

Be sure to email peter@peterfaludiconsulting.com.au and register your interest NOW and get on the VIP list!

REAL ESTATE INVESTMENT ALERT NO. 15

SEPTEMBER 2018

In this newsletter we discuss two very important matters which are potentially major impediments to successfully funding real estate development projects in the current market:

1.   What happens if your lender cannot fund the loan; and

2.   When is a presale not a presale?

WHAT HAPPENS IF YOUR LENDER CANNOT FUND THE LOAN

Following our previous Newsletter, in which we highlighted the need for borrowers to do due diligence on their lenders in the current market, we thought it would be useful to touch on some issues that need to be considered if a lender is no longer able to fund a loan it has agreed to provide.

Although this scenario is not one which borrowers previously had to consider when their funding was provided by the major banks, with the large number and variety of non-bank lenders currently in the property finance space, this has become a live issue which needs to be considered.

Is the Financier really committed to fund?

All financiers (both bank and non-bank) will include wording in their initial letters of offer or term sheets which make it clear that such terms are indicative only and do not constitute an offer of finance or bind the financier to provide the facility. This is standard market practice.

What is, however, becoming more common (mainly for non-bank lenders) is that even the formal credit approved letter of offer or term sheet may contain wording which can be relied upon by the financier to withdraw from the transaction. Clauses which refer to the need for the financier to have its funding in place or to formalise commitments from its investors, or which provide that there may be delays in meeting deadlines for funding, need to be carefully understood.

Although such clauses may be reasonable given the source of the funding to be relied on by the financier, from a borrower’s perspective any possible withdrawal or delay can have serious consequences. It is therefore important that a developer/borrower is aware of this risk before deciding to proceed with a particular financier.

Steps a Borrower can take to minimise the risk.

As the above phenomenon is relatively new, there is no standard market practice that can be adopted by a borrower to mitigate this risk.

We provide below some suggestions which could be adopted or negotiated to arrive at a more acceptable position for both parties.

Do more due diligence

Borrowers should look into the track record of the proposed financier and see if they have successfully funded other developments of similar size and complexity to the proposed project. If possible speak to other borrowers who have used the financier to determine if there were any delays from a funding perspective during the course of the project.

Ascertain the source of funds to be used. If the money is that of a large domestic or offshore superannuation or pension fund, or is institutional or private equity money, the risk of funds not being available may be less relative to funds to be provided by individual wholesale investors.

If funding sources are domestic, this may also reduce the risk of delay or withdrawal relative to funds sourced from offshore.

Reputation is very important to most financiers. Accordingly, dealing with an established financier or investment manager which would regard the protection of its reputation as important should give a borrower comfort that the risk of delay or withdrawal will be minimised.

Verify availability of funds

Although this may not be acceptable to some financiers, for a large transaction or a significant borrower, it may be possible to request the potential financier or relevant investment manager to provide evidence of the availability of the funds in Australia.

The nature of such evidence would need to be discussed. I was involved in a large matter where a government body on whose land our client was going to carry out the development required such evidence from a foreign developer. The developer (which was funding the matter without debt) simply placed the full amount in a bank account and provided statements to the government body each month to verify the amounts available.

Although we are not suggesting this would be usual, it does demonstrate that where there is a will there is a way to deal with this concern.

Ask the financier to assist in finding alternative finance

It would not be unreasonable for a borrower to ask its financier to assist in finding alternative finance should the financier withdraw from the loan or be unable to continue funding.

This should be discussed and agreed upfront and documented in a way which gives the borrower flexibility to also seek alternative funding. Most financiers would not wish to be bound to find an alternative financier but may be willing to give the borrower some assistance in doing so.

WHEN IS A PRESALE NOT A PRESALE?

A key condition precedent for any development/construction financier (bank or non-bank) is the level of qualifying or complying presales which have been entered into by the borrower/developer.

Although the minimum level of qualifying/complying presales required can vary between financiers, certain other requirements which must be satisfied in order for a presale contract to be regarded as qualifying or complying are fairly consistent between financiers.

From a developer/borrower’s perspective, it is very important to ensure that it does not enter into presale contracts which will not satisfy the financier’s requirements. The lawyers involved in drafting the form of master presale agreement as well as in negotiating individual contracts with potential purchasers need to be aware of the financier’s requirements or likely requirements.

Failure to have the required level of qualifying/complying presales can prove fatal to developers/borrowers.

Key requirements which are consistent across the market include:

1.   The amount of deposit which must be paid by the purchasers when entering into the contract, which is usually 10%,

2.   The sunset date by which the construction must be completed and the strata plan registered, which is normally at least 12 months after the scheduled date for practical completion as contained in the building contract; and

3.   The absence of any right for the purchaser to terminate or rescind the presale contract in the case of the insolvency of the vendor. This is particularly important as a financier needs to be able to appoint a receiver on enforcement of its facility without such appointment triggering such a right for the purchasers. Similarly, it would not be acceptable if purchasers could exercise such rights in the case of the appointment of an administrator to the vendor.

Although the new ipso facto rules, which came into force from 1 July this year, may have the effect of preventing purchasers from taking advantage of such clauses, from a financier’s perspective it will always by preferable if the contract does not contain such right.

We have seen the devastating consequences which can flow to a developer where the desire to enter into presale contracts to satisfy the minimum level of presales required has actually resulted in finance not being available for the project due to the presales not complying with the financiers’ requirements.

The above risks need to be understood by developers and their advisers in order to minimise potentially fatal consequences.

If you would like to discuss any of the above please feel free to contact us.

Peter Faludi Consulting

Connect with me on LinkedIn

https://www.linkedin.com/in/peter-faludi/ 

Subscribe to our Website

http://www.peterfaludiconsulting.com.au

Call  0401 500 528

Email  peter@peterfaludiconsulting.com.au

The comments made in this Alert do not constitute the provision of any legal, tax or accounting advice by Peter Faludi Consulting or any Director or employee thereof and therefore you should not rely on this Alert in making any decisions relating to present or future transactions in which you are involved. We strongly recommend that you seek legal, tax and/or accounting advice (as relevant) in relation to the same.

Copyright © Peter Faludi Consulting. All rights reserved.

Comments are closed.