Development finance: an update
Helen Andrews, Phil Abbott and Iain Thomas published an article in January discussing development finance and particular real estate asset classes.
Since then, the landscape has changed rapidly, prompting this update by Phil Abbott and Dominic Tyler.
Different sectors are affected in different ways.
Logistics, already popular, is booming as consumers are almost solely buying their goods online and we may see this trend continue post COVID-19 lockdown restrictions being relaxed. Retail and hospitality, on the other hand, are suffering because of the current, albeit temporary, closures.
While many of our comments in the original article remain accurate, there are additional practical considerations on deals where development financing is in place and the asset is in the process of construction.
As a starting point, lenders, borrowers and their lawyers will need to look carefully at the terms of underlying loan documentation to work out whether a loan that has not been fully drawn can be draw stopped and, if so, how.
Construction delays, temporary abandonment, potential cost overruns as a result of supply chain difficulties, delays in obtaining planning permissions or reaching planning milestones and other relevant events of default may constitute a draw stop event, which would affect a borrower's ability to draw down additional funds.
Borrowers should be alive to scenarios that may allow a lender to call a draw stop and engage with their lenders to achieve a suitable outcome (which could include specific waivers to allow ongoing construction).
Those that are in the early stages of development (such as design) may be progressing in line with their programmes, at least initially, due to the ability to do much of this work remotely. However, those that are on site will be affected.
On site developments rely on an adequate supply of staff and materials to progress and shortages of both, together with restricted ways of working will impact on agreed completion dates.
From a funding perspective, it is important that lenders underwrite potential for delays and have levels of contingency to deal with them.
In particular, increased expenditure above agreed thresholds (or any extraordinary expenditure) which would result in changes to an agreed development budget would likely need lender approval.
Lenders and borrowers should therefore engage, at an early stage, to assess their current situation and work out whether changes are needed to a development budget and the financial viability of doing so.
Borrowers should therefore be flagging any concerns with meeting the agreed completion timetable to their lenders.
Whether this is to lenders considering draw stopping or to borrowers seeking clarity on loan documentation compliance in these exceptional times.
Since then, the landscape has changed rapidly, prompting this update by Phil Abbott and Dominic Tyler.
Different sectors are affected in different ways.
Logistics, already popular, is booming as consumers are almost solely buying their goods online and we may see this trend continue post COVID-19 lockdown restrictions being relaxed. Retail and hospitality, on the other hand, are suffering because of the current, albeit temporary, closures.
While many of our comments in the original article remain accurate, there are additional practical considerations on deals where development financing is in place and the asset is in the process of construction.
1. Draw stops?
Cass Business School, in its latest Commercial Real Estate Lending Report, states that there are over £22 billion of development facilities outstanding. Further, there are also over £25 billion of undrawn development facilities. Will these funding lines remain available or not?As a starting point, lenders, borrowers and their lawyers will need to look carefully at the terms of underlying loan documentation to work out whether a loan that has not been fully drawn can be draw stopped and, if so, how.
Construction delays, temporary abandonment, potential cost overruns as a result of supply chain difficulties, delays in obtaining planning permissions or reaching planning milestones and other relevant events of default may constitute a draw stop event, which would affect a borrower's ability to draw down additional funds.
Borrowers should be alive to scenarios that may allow a lender to call a draw stop and engage with their lenders to achieve a suitable outcome (which could include specific waivers to allow ongoing construction).
2. Equity
If a lender does call a draw stop, particularly if the reason given relates to cost overruns, sponsors and borrowers should consider their ability to inject additional equity into the structure and whether this is an option to ensure the development can progress. This may be more viable where a development is nearing completion.3. Labour and material supply chains
With both labour and material supply chains severely affected due to the current lockdown and social distancing measures, it is highly likely that developments will see delays in the coming year.Those that are in the early stages of development (such as design) may be progressing in line with their programmes, at least initially, due to the ability to do much of this work remotely. However, those that are on site will be affected.
On site developments rely on an adequate supply of staff and materials to progress and shortages of both, together with restricted ways of working will impact on agreed completion dates.
From a funding perspective, it is important that lenders underwrite potential for delays and have levels of contingency to deal with them.
4. Budgeting and financial modelling
Many agreed development budgets did likely not contemplate the current economic climate. Financial modelling and budgeting may therefore need to be reviewed to assess whether changes are needed to ensure the continuing viability of a development and whether statutory payments such as community infrastructure levy or s106 contributions can still be met.In particular, increased expenditure above agreed thresholds (or any extraordinary expenditure) which would result in changes to an agreed development budget would likely need lender approval.
Lenders and borrowers should therefore engage, at an early stage, to assess their current situation and work out whether changes are needed to a development budget and the financial viability of doing so.
5. Completion dates
With the inevitable delays to developments as we have alluded to, lenders and borrowers should consider discussing extensions to existing completion longstop dates. A failure to meet completion longstop dates would likely result in an event of default, for obvious reasons.Borrowers should therefore be flagging any concerns with meeting the agreed completion timetable to their lenders.
How can we help?
For those that are encountering difficulties in their development financing or anticipate that difficulties may arise in the coming weeks and months, our experienced team of specialists are here to assist both lenders and borrowers in navigating the current climate.Whether this is to lenders considering draw stopping or to borrowers seeking clarity on loan documentation compliance in these exceptional times.