Ticking the boxes

Mark Farrands has viewed hundreds of loan applications in over 20 years of working in finance. Many of these were with Westpac and more latterly ASB Bank, where he was Auckland regional manager for property finance.

Last year he was appointed to head the New Zealand operation of MaxCap Group, a leading Australian non-bank commercial real estate lender which has established a joint venture in New Zealand with Bayleys and Forsyth Barr.

Farrands identifies the following key considerations for property investors when seeking funding, and outlines situations where non-bank funders may be able to help facilitate a transaction.

LOAN-TO-VALUE RATIO

It’s important to know what level of debt lenders have an appetite to fund. Banks will lend up to 60 per cent of the value of a commercial property, and at that level may require monthly principal reductions from the outset.

Non-bank funders may provide a higher level of funding. However, this usually comes at a higher cost.

INTEREST COVERAGE RATIO (ICR)

This lending ratio measures how many times the annual income generated by a property services the annual interest of a loan. Before the global financial crisis, banks were willing to accept ICRs below 1.5 times – now they seek at least two times.

If you’re purchasing a property that has vacancies and cannot initially hit the bank’s ICR hurdle, a non-bank funder may be able to provide a short-term facility allowing a landlord to lease up a property until it’s in a position to be refinanced by a bank.

SEISMIC STRENGTH AND ASBESTOS

“What’s the building’s seismic rating?” and “does the building contain asbestos?”. Financiers will request this information, and may not fund the property without a strategy to address the risks. To confirm a property’s seismic rating a purchaser should request an engineer’s assessment from the vendor, or commission one.

A building report should provide confirmation on whether the property contains asbestos. Non-bank lenders may be more flexible around the treatment of these risks and may be able to assist with the initial settlement of the property and funding to address the issues to position the property for a main bank to refinance.

LOCATION

Invest in areas where there is a catchment suited to the property. For example, for retail look for high pedestrian flows, good parking and public transport; for residential, availability of schools and public amenities. Also consider changes proposed for the area by government or local authorities. A lender is likely to look at all these factors.

TENANCY PROFILE

Most lenders will look for certainty of income from strong tenants with long lease terms to confirm the loan interest can be serviced.

“If all the above factors are not de-risked sufficiently for a bank to initially have an appetite to fund a transaction, you could consider approaching a non-bank lender that can provide more flexibility,” says Farrands.

“This could allow you to reposition the asset for sale or for refinance to a bank once the asset has been stabilised and value added.”

He says there are also areas of the market where banks are increasingly reluctant to venture, and where alternative lenders may be able to help facilitate a transaction, such as land acquisition for development.

“It can also be difficult now to obtain bank finance for projects where the funding requirement is large ($40 million upwards).

“While there is occasional appetite from main banks for loans in these areas that meet their criteria, parameters continue to tighten, with lower gearing, larger equity requirements, higher debt coverage from presales, etc.”

Farrands says another challenge for property developers in a market where construction costs are rising rapidly is locking down their development costs sufficiently for a funder to become involved.

“Often costs can increase further while presales are being sought. It’s not uncommon for projects to need to be redesigned once builders have priced the initial plans, in order to ‘value engineer’ the costs to an acceptable level so a project is profitable.”

An option for countering this is early contractor engagement – choosing a good builder early on to partner with and involving them in design to achieve cost efficiencies.

“The good news for developers is that there are now experienced alternative lenders in the market filling the gap left by the main banks and providing flexible financing solutions,” says Farrands.

“As projects tend to take longer to achieve presales in the current market, we are seeing a growing trend of borrowers prepared to pay a premium for debt coverage flexibility. The size of the premium will depend on the level of flexibility required.

“This facilitates project certainty and momentum. There are now options for a borrower to commence with less than 100 per cent debt coverage from sales.”

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