Advice and Opinion

Residential developers struggle to obtain finance

South African developers looking to obtain finance to build and sell, or to build and hold and rent out, such as town house complexes, flats, or retirement developments, are struggling to acquire funding from banks. This is according to Gary, Palmer, CEO of Paragon Lending Solutions who says due to the bad debt that was accumulated as a result of residential developers defaulting during the financial recession, banks are wary of approving loans to developers who haven’t secured the required level of pre-sales for the transactions where developers are looking to build and sell to 3rd parties. Banks are also wary of financing developers who are looking to build, hold and rent out, because pre-lets are difficult to obtain prior to construction and normally residential leases are only signed for 12 months.

Palmer says that after the financial recession the South African property market shifted its property investment preference from residential to commercial property, due to commercial property being a safer and more lucrative investment at the time. He says that over the past few years the market has however shifted its preference back to residential property once again, as the demand for residential rentals has increasing steadily.

“This trend is evident in the increase in loan applications for capital to build and sell, or to build and hold residential property developments which Paragon Lending Solutions has experienced. We believe that it is due to the increase in the demand for rentals. We are however finding that the banks have not yet adapted to this trend, and still have tight policies in place when it comes to lending to residential developers. In certain areas we are seeing unprecedented demand for residential rentals with rental escalations of 7% to 10% with less than 1% vacancy is also being achieved.

Palmer explains that most South African lenders require pre-sale agreements to be in place when dealing with residential development finance, which is a contract that states that the property in question must be sold before a developer’s loan is paid out, is often required by lenders as it provides assurance that the developer will have the capital available to repay the loan taken to develop the property. He says that banks often require a condition of 120% pre-sale requirement, which he believes is unrealistic and difficult for developers to obtain.

He says that another reason why banks don’t often approve loans to developers for residential property in South Africa is because in the past, developers have not been able to sell the units that have already been developed, leaving them unable to repay the loan and resulting in the bank with an incomplete building to pay off. “This concerns banks the most.”

Palmer says that however, developers who are struggling to obtain funding for a development from banks could consider alternatives such as non-bank lenders that are able provide short-term, asset-backed funding secured against residential, office, industrial and retail properties. He says that as a result of the stricter lending regulations in South Africa, he has experienced an increase in the number of property developers seeking alternative solutions. “These alterative solutions are often able to provide individuals with tailored options that will suit their requirements should a bank not be able to assist with a certain situation,” concludes Palmer.