Development finance: navigating the legal process

Here at Newmanor Law we focus on commercial real estate and one of our main areas of activity is development finance.  In 2020 we helped lenders complete 28 loans with an aggregate value of £96m.

Philosophically (not a word you hear often in the law) we like to work collaboratively, not confrontationally, and we aim to help everyone involved in the transaction because that’s the way we get the loan advanced, smoothly and swiftly.  In the spirit of working together, we present Newmanor Law’s five tips for developers who have agreed terms with their lenders and are now moving to legals.

The theme to all our tips is clarity.  Development is often a bit of a juggling act and to keep the balls airborne everyone involved needs to be clear about who’s doing what, and when they are doing it.

Clarity on timing

The big question here is: when do you need the money?  In theory we can get the legals done in three or four weeks, but that depends on everyone being aligned around that target date.  A kick-off call is a good idea.  It is your opportunity to brief the lawyers on the project so that we get a sense of what’s relevant and what’s not.  If there are any sticky issues, this is the time to air them: don’t wait for them to come up at the last minute.  If we are going to get to the finish line in three or four weeks, your solicitor needs to have all the necessary information to hand from the start, and some money from you to give the costs undertaking to the lender’s lawyers.  Searches have never come through quickly, and they are even slower these days, so it makes sense for your lawyer to order them in advance.

Clarity on procurement

As a general rule, the lender is going to want to be comfortable with the structure of the procurement and the documentation backing it up when the first loan is advanced.  So discuss your procurement route with the lender from the beginning and have your project directory ready.  In bigger developments, traditional/design and build with risk transferred to a solid contractor is likely to be required, but in the smaller ticket environment a risk transfer to an in-house contractor is likely to be acceptable.  Occasionally, if you can show a strong track-record of similar developments, construction management might be fundable, but the absence of a fixed price makes many lenders uncomfortable.

Clarity on insurance

More times than not, insurance is one of the last items to be ticked off the lender’s conditions precedent checklist.  Sometimes that comes down to misunderstandings with the contractor about who is insuring what, but mostly it depends on the quality of the insurance broker.  There are some terrific insurance brokers out there who really understand the issues and know how to find the right cover to keep the lender happy, but there are others who don’t.  Insurance is a very technical subject with its own esoteric vocabulary.  Lenders need to be composite insured and first loss payee, and they need a waiver of subrogation rights and non-invalidation and non-vitiation clauses.  If your insurance broker says it can’t be done, they are wrong, and you probably need to find a new one.

Clarity on valuation

Lenders place a cap on the amount developers can borrow based on a percentage of gross development value or, in the case of an acquisition bridge, market value.  So even if the termsheet says they will lend £1,000,000, if the property valuation doesn’t support that amount at the agreed loan to value, the bank will lend less.  So it is very important to get the right valuation and, in the context of a development, that means getting the best consent you can that delivers the best GDV.  If you are going in for enhanced planning, bear in mind that the lender won’t take it as a given that you will get the consent you are looking for, even if you have submitted it and things are looking good with the local authority.  The best bet for a swift drawdown is to make sure you’ve got the right scheme to support the loan from the start.

Clarity on pricing

As a developer you need to keep your costs nailed down.  Typically you will have a fixed price from your contractor/trade contractors and your consultants.  You pay more for extras but you don’t pay more for delays caused by them.  For reasons mired in the past, a lot of lawyers don’t subscribe to that same ethos.  Rather than fixed prices, lawyers often give quotes which are based on hours, and the quotes are full of exceptions that allow them to charge more.  Get fixed price lawyers who are incentivised to close the transaction swiftly, not hours-based lawyers who are incentivised to drag things out.