Reducing risk in a tight lending era
Recent reports in the media of credit constraints are a concern within the commercial property sector, but industry experts say developers and purchasers can maximise their chances of securing funding by taking greater steps to minimise risk.
John Church, Bayleys’ national director, commercial and industrial, says that although the media has mainly focused on the impact tightened lending requirements has had on apartment developments, commercial property investors have felt the pinch too.
“The major banks are responding with caution to current market conditions, preferring to adopt a stricter approach now rather than continue to supply an already buoyant market with cheap finance and risk undermining financial stability in the wider economy,” Church says.
“There is much more emphasis on minimising risk, and the thresholds that need to be met to obtain funding are higher. In a market where lenders are being more selective about the projects they finance, it is essential for borrowers to demonstrate to lenders that they are mindful of the banks’ changing appetite for risk.”
Anecdotal evidence suggests “new- to- bank” lending is tight, with banks prioritising lending to existing clients and projects over new clients.
Alistair Law, a partner in the property team at law firm Anthony Harper, says that maintaining a sound relationship with the banks is important in the current environment.
“That i sn’t to say that it’s impossible to obtain funding if you don’t have a strong relationship with the bank or that you are guaranteed funding if you do but being an existing client makes it easier to show that you are a trustworthy, prudent borrower with a proven track record.”
Law says the banks now want borrowers to commit greater levels of equity to projects.
“Equity levels of around the 40 per cent mark used to be acceptable, but now the sweet spot i s somewhere between 50 and 55 per cent.
“Borrowers are likely to fulfil their equity requirements through shareholder loans, in which case they need to be mindful to ensure that such arrangements rank behind the bank’s security.”
For developers, the main area of concern is usually the certainty of development costs in their feasibility study. “They need to demonstrate that there is sufficient tenant leasing commitment,” Church says.
“Key agreements that support a project need to be in place before approaching the banks for finance. With leases, banks will want to verify that the commercial terms are not onerous and that they are satisfied with the covenant strength of the tenant and any guarantee or other security arrangements.”
A major difficulty for developers is that development costs are not usually locked down until they have achieved a certain leasing commitment and bank funding has been obtained. An option could be for developers to consider getting a contractor on board earlier so that the development costs in the feasibility study are more accurate, Church says.
For investors looking to acquire existing commercial properties, the main issue is cash flow serviceability. “The banks may have previously made assumptions based on the rental yield generated from the property, but they appear to be carrying out much more detailed investigations,” Law says. “Present- ing the bank with a detailed, longterm maintenance plan prepared by a building surveyor or similar expert is a great way to demonstrate how the customer intends to manage the risks associated with the investment.
“Banks are very focused on reports confirming the building achieves an acceptable seismic rating ( usually above 67 per cent of new building standards) as the costs of any such works are likely to be significant and unable to be passed to tenants.”
Legal risks associated with commercial property investment can be assessed through due diligence. “Engaging a commercial property lawyer to carry out a quality due diligence review will identify the key legal risks for the property,” Law says.
“A legal due diligence report will identify risks such as incomplete lease documentation, tenant early termination rights, onerous lease clauses and outstanding statutory or regulatory requirements.”
Church says vendors should also be alert to the difficulties their purchasers may face raising finance in the current market.
“Before putting a commercial property on the market, it would be advisable for vendors to carry out their own high- level due diligence. It is unclear how long the current credit conditions will last, so taking steps that show the banks a project is as derisked as possible should remain at the forefront of property developers’ and investors’ minds.”