There's no margin for error, broker warns
Borrowing the entire cost of a property development is a high risk move that could leave investors and developers vulnerable, specialist broker Saam Lowni (pictured left) has warned.
“One hundred per cent (100%) debt might look attractive, but it is riddled with risk,” declared Lowni, founder and managing director of Merryoaks Finance. “You may assume that as a finance broker I'd encourage 100% debt or 110% if I could get away with it. But in reality, full debt capital stacks can leave developers in a vulnerable position. Therefore, I do not recommend it.”
Lowni continued: “When the entire capital stack is debt, there’s no margin for error. If sales slowdown or build costs rise, the risk isn't just reduced returns, it's insolvency. That's how overleveraging leads to distressed sales or, even worse, a cycle of debt covering old debt. High leverage only works when everything goes exactly to plan, which is rare. In my opinion, a well-balanced structure gives better long-term outcomes.”
Increasing numbers of specialist lenders are embracing this level of finance though, according to Bob Singh (pictured second from left), a director of Chess Mortgages, and a specialist adviser in development and commercial lending.
“In the same way as the residential market is ever evolving, the same can be said of the specialist lenders who in the quest to lend more are entering the grey area of 100% finance for developments,” said Singh. “Totally 100% funded projects are rare unless secured by other assets but if the asset is owned outright already then 100% funding is quite common. For the experienced borrower this is not a big risk and for the lender who has undertaken full due diligence on the client, the financials, the contractor and the property, then most risks can be mitigated.”
He added: “In an environment where we have a housing and skills shortage and ever increasing building costs this is no longer the domain for a novice. The legal knowledge to be complaint is another often ignored aspect of development and can cost the client dearly if not followed. Due to the cost of development finance most borrowers will keep debt to a minimum and use a combination of debt and equity to mitigate risk. It goes without saying if you fail to plan then plan to fail.”
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How easy is it for developers to obtain 100% finance?
It is possible to obtain effective 100% funding in development but Neil Leitch (pictured second from right), managing director of development finance at Hampshire Trust Bank, believes it is rare. “It would only generally be possible if the scheme is being funded from a mix of senior debt and mezzanine. The former would cost standard bank rates whereas the latter would accrue an interest rate of 18% - 30%. The only other circumstances where a100% loan is possible is where a scheme is particularly profitable. No developer needs to obtain funding for their profit so on particularly profitable schemes, it may be possible to obtain 100% of costs and maintain loan to gross development value (LTGDV) covenants of 65%.”
He added: "There is a balance of risk in any transaction. Banks like us provide senior debt. We generally don't provide mezzanine funding and neither are we any client's joint venture partner. There is an expectation that if the bank is providing a senior debt, a borrower usually provides equity, usually at a level of 10% - 20% of total costs. So, it's possible in particular circumstances but it's likely to be expensive. It can, however, work in the right structure."
For Maxim Cohen (pictured right), CEO of UK finance Group, 100% development funding must always be assessed on a case-by-case basis. “This is not a product that should be offered as a blanket solution,” Cohen said. “It requires individual underwriting, tailored to the specific developer, their track record, personal guarantee exposure, and project rationale. I’ve seen firsthand how 100% funding can create unexpected risk. One client was effectively fully funded — not because they secured a formal 100% product, but because the initial valuation and gross development value were overly optimistic.” As a result, they borrowed more than they should have. When it came to exiting the loan, the final market valuation came in significantly lower, and they were unable to refinance.” He added: “We ultimately had to secure leverage against other properties to repay the loan. This highlights a key risk with 100% funding - if the end valuation doesn’t match expectations, the client may struggle to exit; a critical factor that must always be considered at the outset.”
Latest data shows a growing trend for zero deposit mortgages among residential buyers too. Some £197m worth of no-deposit mortgage funding was issued last year, according to chartered accountants and business advisers Lubbock Fine. Borrowing levels, though, are still far below financial crisis-era levels, where Northern Rock offered 125% mortgages.
