In this blog we cover the range of finance options available for the Construction Sector. The options can be complex, so for impartial advice it’s always good to speak with a commercial finance broker who will be working for you and not the lender.
The Construction sector is broad and so are its finance needs. To help dissect the sector let’s look at the finance available, grouped in the following categories:
For Contractors and trading businesses: Working Capital Finance and Asset Finance.
For Housebuilders: Development Finance.
For Refurbishment: Bridging finance and Refurbishment Loans.
For Contractors / Trading Businesses
There are two key types of finance to consider: the first isWorking Capital Finance / Invoice Finance and the second is Asset Finance.
Working Capital Finance / Invoice Finance
In every business cash is king, and liquidity, or cash flow is vital to keep construction projects viable. Working Capital Finance / Invoice Finance is useful for construction businesses with cash flow issues. This is particularly relevant in a period of rising material costs and extended payment cycles.
Working Capital Finance / Invoice Finance gives you access to working capital raised against unpaid bills. Lenders will also advance money against applications for payment which are not actual invoices. The lending available will be based on the financial strength of your debtors and will be determined by credit limits and concentration of risk, from the lender’s perspective.
Lenders will also advance funds against security placed against the borrowing. This could be a personal guarantee or tangible assets. Be sure to consult a commercial finance broker and/or take independent legal advice on the legal implications of this type of borrowing.
The cost of hiring equipment long term can be expensive and can be a drain on short term cash flow. Asset Finance can help. A deposit of 10% is standard – though lenders will often look for a higher deposit for a relatively new company.
For Housebuilders: Development Finance
Given the huge upfront costs of housebuilding, it’s unlikely that developers will have all their required funds in the bank.
Depending on the size of the construction company, and the project/s that they are working on, there is a natural ‘ecosytem’ or ‘food chain’ of lenders in the market, and it’s important to understand which is right for your business. It’s also important to recognise that the various types of lenders have their specific lending policies and credit risk limits.
Development funding lenders can be put into five key categories: High Street; Specialist Lenders; “Other” lenders; Mezzanine Funding and 100% Funding
Let’s consider each of these in turn:
High Street lenders
Typically, they have a very limited appetite for commercial development. Their focus is more often on residential development, where there is a desire for lending. Typical these lenders will only fund up to 65% Loan to Cost, or 55% Loan to GDV at rates around 4.5-5% per annum, with Arrangement fee, valuation and legal fees and monitoring fees on top.
Experience is key, with lenders looking for evidence of previous, similar sized schemes with proven profit. Developers also need to be mindful of climate management and sustainable practices. For example, new builds need an EPC of D or above.
Lenders will want evidence that planning consent is already in place and will need to see a clear build and sales plan, which allows for a good exit, as a lender.
Despite the confidence of a developer, High Street lenders tend not to like joint ventures, and need to be clear about who the client is.
These lenders also have a limited appetite for commercial schemes, and specifically don’t like speculative builds. They may consider pre-let/pre-sold developments with lower loan to gross development values (LTGDVs).
They have a good appetite for residential development but still want clear evidence of experience on previous schemes. They will often consider up to 70% LTGDV and up to 90% Loan to Cost but are looking for schemes with a borrowing requirement of around £400-500k, sometimes more.
Typically, these lenders will consider applications for up to 125 residential units or 200 on office to residential permitted development rights (PDR) schemes. They also have a good appetite for student schemes where there is burgeoning demand.
The lending challenges are rising build costs, including materials and labour costs, and planning permission timescales and more due diligence is being carried out on developers’ contingency plans for over runs but in terms of cost and time.
Typically, specialist lenders require an arrangement fee of 1.5%. Borrowing rates are 6 to 7% per annum plus monitoring costs. If required, mezzanine funding can be used to lift the loan to 75% GDV.
There is a good appetite amongst this lender group for residential developments. They are not so strict on experience and will consider first time developers, but they do want comfort in the ability of the developer to complete the scheme. After all, they want to know that the borrowings will be repaid.
These lenders will go up to 75% LTGDV and will include smaller loan sizes. There is usually an arrangement fee of 1.5 to 2%, with rates at 1.00 -1.50% per month plus Monitoring Costs. In some cases, 100% funding can be available. These lenders are key to funding those smaller schemes.
Full funding can be availabletoexperienced developers, or those who have previously developed for someone else but not for themselves.
Lenders providing 100% funding will be looking for a planned profit margin of 27% or more, excluding finance costs, and will want a 50% profit share after finance costs.
This is always a popular end of the market and attracts developers who require funding help with cashflow. The solution is often bridging finance, from Tier 3 lenders, which is available at up to 75% against purchase price.
Refurbishment loans are usually pitched at 75% against Purchase price, with further advances to help with build costs, or with some lenders, 90% against purchase price with the borrower funding the refurb costs.
Why should I use a broker?
It can make good sense to use a commercial finance broker, as they have insight on – and access to – a wider range of lenders and products. Their knowledge of the market can save you time in sourcing the right finance.
Commercial finance brokers can also package your application to achieve the best outcome with lenders and advise on the best solution for your business.
A good broker should not commission biased, and therefore may charge a fee for their valuable service.
Additionally, commercial finance brokers normally have a broad network of contacts who can assist with other areas of your business.
Essentially, a commercial finance broker will be working for you, not the lender, and their efforts will be focused on finding you the right deal with the right lender.