Insights from the frontline: Small and medium-sized developers struggling to secure finance? A comprehensive funding strategy is essential

As the saying goes, 'Provisions must be ready before the army moves.' It is particularly apt for New Zealand's property development and construction industries.

 

As another wave of widespread interest in development gathers momentum and the Medium Density Residential Standards become law, demand for loans and finance among small and medium-sized property developers continues to grow. Throughout development and construction, securing sufficient financial 'provisions' is one of the earliest and most difficult tasks, and one that particularly benefits from experience:

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Compared with ordinary home loans, development loans involve more complex requirements, greater difficulty, longer timeframes and more challenging stages, where a single change can affect the whole project. This makes overall project planning more important, funding sources more diverse, financial structures more complex and funding requirements greater. In certain circumstances, cross-border entities and measures to avoid compliance risks are also involved.

 

Vicky Xi, a financing partner at Squirrel Group, has nearly a decade of experience in New Zealand banking and previously served as the New Zealand government's Director of Cross-Border Investment for Greater China. With extensive experience in New Zealand's financial system and a thorough understanding of the financing and lending rules used by major commercial banks' property divisions and finance companies, she has considerable expertise in land purchase, development and construction loans. At YIJU New Zealand's invitation, Vicky is sharing her development finance experience with the magazine's readers for the first time.

 

Case one

Mr A, a first-time developer moving into the industry, had two townhouse developments on Auckland's North Shore. He originally had a partner, and they had unconditionally purchased two properties on large development sites and paid 10% deposits. When the partner withdrew midway through, Mr A had to repay the departing shareholder's investment and bear all project development costs himself. This left him under severe financial pressure, at one point unsure how he could continue.

 

Case analysis:

Mr A approached Vicky for help with finance. After examining and analysing the project in detail, she identified several issues affecting its financing. First, the original lender had indicated it would fund 100% of project costs, but New Zealand then entered its first lockdown because of Covid-19. With uncertainty in the property market, the lender reduced the loan amount. Second, bank lending generally requires presales with 10% buyer deposits. Several units had already been presold with 5% deposits, and the lawyer could not remedy this. The lender found it difficult to accept some presales with 5% deposits.

 

The pandemic's force majeure effects, combined with presale deposits that failed to meet requirements because the developer did not understand the financing rules, reduced his borrowing capacity and could even have brought the entire project to a halt.

 

Outcome:

After becoming involved, Vicky quickly joined the project planning and design process and led the funding strategy. Following professional analysis, she decided to use debt financing to help Mr A secure a loan. To address the lender's reduced loan amount, she arranged joint financing using Squirrel's own funds and a partner lender. She coordinated negotiations between the developer's team and the lender over loan terms and details, successfully persuading the lender to accept the existing presales with 5% deposits. Together, they provided all the finance needed for land settlement, resource consent and subdivision, and subsequent construction.

 

On the day construction began, the developer recovered all his own funds already invested in the project and put them into subsequent projects. Drawdowns proceeded very smoothly throughout. Mr A's first project is now nearing handover, the second is approaching roof completion, and he has already begun planning and buying land for several future projects.

Case two

Mr B was both a developer and a builder, specialising in medium-density housing and standalone homes in new subdivisions. Unlike Mr A, he was a relatively conservative, experienced developer. In this case, his company was progressing several projects in different locations simultaneously, including the development and construction of more than thirty units in central Auckland.

 

Like many developers who have grown by 'snowballing', Mr B relied mainly on company profits and mortgages from mainstream banks. As the company expanded, however, allocating funds became increasingly important. Previously routine practices, such as transferring money between projects and borrowing from friends, were limiting the company's growth. The central Auckland development faced delayed receipts from another project running at the same time, forcing Mr B to raise NZ$2,000,000 in construction funding at short notice to maintain cash flow. His bank manager said he had reached his borrowing limit and could not borrow more. Mr B had also considered selling an investment property cheaply to meet the immediate need, but with house prices continuing to rise, he was reluctant and hoped for a better solution.

 

Case analysis:

Through detailed discussions with Mr B, Vicky learnt that, beyond reaching his borrowing limit, his projects also failed to meet basic bank lending requirements. None had presales or quantity surveyor reports, both of which were essential for a bank loan. Securing bank finance against the projects was therefore almost impossible.

 

Mr B's situation was not unusual.

 

Generally, presale performance largely determines how much a developer can borrow from a bank. However, building material prices and construction workers' wages are still rising, while presale prices are usually lower than prices achieved after completion. Without careful planning, presales can leave developers facing sharply reduced profits. It is therefore understandable that developers who do not need bank finance may prefer to avoid presales.

 

In years of practice, Chinese builders and developers have also rarely commissioned QS reports. For an ordinary developer, these represent a substantial expense. Disagreements over cost estimates and subcontractor selection also often delay construction and, in some cases, have even caused funding to break down.

 

Without presales or a QS report, however, developers can encounter difficulties if, like Mr B, they unexpectedly need short-term construction funding.

 

Outcome:

Despite Mr B having no presales or QS report, Vicky analysed the best funding approach and decided to use a small, low-interest Squirrel Money construction loan. Funds were advanced quickly, resolving his urgent need.

 

Explaining why she could make a different lending decision from a bank, Vicky said banks rely on QS reports because their decision-making systems are more complex and require advisory reports from other professionals to assess risk. By contrast, the Squirrel financing team she leads comprises finance and property specialists with their own assessment criteria. They can assess Mr B's projects against current market conditions without relying entirely on valuation reports. Their expertise allows more flexible lending terms and faster funding.

 

Professional advice

 

Among property development funding options, bank finance has the lowest financing costs, with interest rates generally below those of other options. Banks impose demanding requirements on developers and projects, however. Borrowers need an excellent management history and development track record to have a chance of success. Beyond these credentials, the presales discussed in the cases are another stringent requirement. Presales lock in selling prices and profit margins, surrendering potential profit in a market that is still rising. Banks generally advance funds on a cost-to-complete basis: developers must first provide the initial funding, meaning the difference between total costs and the loan amount, and every drawdown must be supported by a valuer's and/or QS report.

 

Finance companies charge relatively higher interest than banks but have less stringent development lending requirements. They focus more on a project's prospects and the value of the security, placing relatively less emphasis on the applicant developer's experience and background. Their lending criteria are more flexible, and most do not require presales, leaving developers to decide when to sell. Most finance companies can lend separately against land and construction, allowing borrowing at the land purchase stage. Construction loan drawdowns are also more flexible, generally requiring only council inspection sign-offs. Most finance companies do not require QS reports for small and medium-sized developments.

 

Vicky believes bank and finance company loans each have advantages and disadvantages, and every project needs a tailored solution. In practice, for example, some medium and large developers choose partial presales to reduce risk, making bank finance potentially more suitable. For medium and large projects, the benefits of bank loans extend beyond low interest rates and fees to funding stability, introductions to contacts and resources, and other less obvious advantages. Many developers are also deterred by banks' relatively strict equity requirements. Vicky recommends diversifying funding sources and, with professional assistance, using other financing methods where appropriate to meet the bank's equity requirements.

 

From years of helping developers secure finance, Vicky has found that even high-quality, well-funded developments encounter unpredictable problems during delivery. These include a partner withdrawing, as in case one, or delayed receipts from another project affecting cash flow, as in case two. A capable financing partner must be able to anticipate and manage risks, and quickly find the best solution when unavoidable risks arise. Developers therefore need a professional, efficient and highly experienced financing partner to minimise the effect of force majeure events on project progress.