Financing Development Overruns
A survey by Reading University looked at UK construction projects over a 15 year period, this report showed that;
- More than one quarter of construction schemes finished over their capital cost limit (HM Treasury, 1995)
- Construction industry clients found nearly one third complained that their projects generally overran budget (Barrick, 1995)
- The Construction Clients Forum (1997) reporting that sixty per cent of clients said that cost targets were not being met
- At the start of 2000 only forty-five per cent of projects were being completed within budget (DETR, 2000a)
The broad summary was that the vast minority of construction projects are ever delivered on time and on budget.
Projects overrun for many reasons, the list below contains some of the more popular responses from the Reading University survey. From all the projects, developers and constructors surveyed the percentages represent the popularity of each overrun reason;
- Client driven (76%)
- Design variations (24%)
- Incomplete design at tender (38%)
- Initial design inadequate or lacks detail (28%)
- General lack of information (44%)
- Design brief lacked detail and definition, badly developed, incomplete, or incorrect (84%)
- Client did not know what they wanted (16%)
- Poor cost advice (31%)
- Inadequate contingency allowance or assessment of risks (31%)
- Designers attitude, input, whims, understanding of cost and value (46%)
- Inadequate cost control (21%)
There are many other reasons but these form the most popular.
In summary what the report shows is that despite experience and professionalism things go wrong, for many of these reasons there is little that could have been done to mitigate them.
Cost overruns happen, timescales are exceeded regardless of the ability of the developer.
The Development Finance Problem
There are few things fixed in any property development or construction project. Generally the only non fluid item is the finance. Increasingly the major banks have become more stringent in enforcing late settlement of development finance, the development lending reaches it’s expiry and the lender wants to be repaid.
At this stage it becomes more challenging for the developer to refinance or seek an extension to the finance in place. The main reasons are twofold; Being that traditional development lenders see a need to extend as being a risk factor, despite the fact that almost every project overruns and; Traditional lenders wanting to put a short limit on property finance terms as a way of exercising some control and influence over the project.
The general trend is for the traditional development lenders to want to be repaid rather than extend. Once a lender has reached this point there tends to be little room for movement, meaning the developer needs to act, quickly.
How To Finance Overruns
The good news for property developers is that there are options available, they are just not immediately obvious or available direct to the developer client.
The positive is that the cost of this type of finance is lower than it was, it has also become quicker to put in place. The fact that you are funding overruns doesn’t matter as that is the precise reason these lending products have been developed.
What makes these finance options better is they don’t need to be just for overruns.
Holding Property To Appreciate Value
What we are starting to see now are developers wanting to hold property that they would have sold at a lower price to repay overdue development finance. There is a trend toward developers holding property at a higher price, confident that given time they will achieve sale without needing to drop the price.
Because it takes longer to sell the developer can exceed the lending approval period. Having an option to refinance and extend the borrowing term allows the developer to achieve the higher sale price and make the whole development more profitable.
If you want to know what each development project would like then get in touch, we can take you through sample cases and provide a guide to cost.
By Dave Farmer
Dave Farmer is founder of Lime Consultancy. A business finance specialist based in West Sussex.