When developers are looking for a new build partner, they put their project out to tender. The evaluation process that proceeds is an intense and in-depth review of pricing, relevant experience, past performance, technical skills, resourcing, and other relevant factors. It is these factors that ultimately drive the decision-making process for the developer, ensuring that the right builder is chosen for the job.
Unfortunately, many developers forget to apply a similar process when choosing their funding partners, instead deciding to focus solely on price. This can result in bad outcomes for banks, non-bank lenders, and developers. Remember, the best funding partners are those that impart knowledge and value during the construction process, as well as offering a competitive price.
Nonetheless, having a robust understanding of pricing models and fee structures used by various lenders is an essential tool in a developer’s toolkit. After all, these fees can have a significant impact on a project’s feasibility. In this blog post we will focus on the various fee structures adopted by different lenders, keep in mind that price should not be the only factor one considers when choosing a funding partner.
Make comparison easier by annualising loan fees
Fees are often charged in relation to specified loan terms, which can make comparison difficult. An appropriate comparison can only be made using annualised fees and costs.
Luckily, headline interest rates are generally quoted on a per annum basis (i.e. 6.95% per annum). However, other fees fluctuate depending on the loan’s term, so annualising them is useful for accurate comparison. Once fees are annualised, we can then add them to the headline interest rate to calculate a finance rate for any given loan.
Types of Lender’s Fees
The Application/Establishment Fee
An application fee is paid upfront by the Borrower and is typically denominated as a percentage of the total Loan Facility. Application fees can range from 0.5% to 3.0% depending on the lender and the type of facility being provided. Upon commencement of the loan, the application fee is usually capitalised (added to the balance of the loan).
Development facilities are typically provided for a fixed term where the application fee corresponds to the term provided by the lender. If the term of the loan needs to be extended, then the application fee will be charged again (usually on a pro-rata basis). Therefore, it is important to annualise application fees.
Let’s look at an example where a lender provides a development facility of NZ$1M to a developer on the below terms:
Type: Capitalised Interest
Term: 6 months
Line fee: 0%
In this instance, the annualised application fee can be calculated as follows:
Annualised application fee = application fee / initial term * 12 months.
So, the annualised application fee would be:
2% / 6 * 12 = 4%
To calculate the finance rate, you simply add the headline interest rate per annum (9%) to the annualised application fee (4%), which in this case would imply a finance rate of 13%.
The Line Fee
Line fees are charged to compensate the lender for their commitment to lend or for holding unused funds in a facility. As mentioned in our blog on development loan structures, interest is typically only charged on the drawn balance of the loan. Therefore, line fees are a way for lenders to offset the lack of interest income generated during the term of a loan, where the average loan balance is well below facility limit provided by the lender. For example, on a development loan which is drawn down in stages, a lender will typically earn only 60% of the quoted headline interest rate in interest income during a 12-month loan.
The usual cost of a line fee is between 0.25% and 3.0% per annum, with the fee charged against either (a) the undrawn portion of the loan, or (b) against the total facility limit (similar to application fees). Understanding what portion of the loan the fee is being charged against is important as it can materially impact the cost to the Borrower. Furthermore, some lenders will quote you a line fee on monthly terms, while others will quote on yearly terms. For example, a 0.25% monthly line fee may not appear large, but on an annualised basis it amounts to 3% per annum, which is significant in the development world.
It is crucial at this point to state that establishment and line fees are not the only fees that may be payable. More recently, we have seen lenders introduce alternate pricing models that include minimum earn provisions, performance fees and exit fees. Other hidden costs such as site visit fees, drawdown fees and early repayment fees are not uncommon and need to be considered when undertaking a simple cost analysis.
Lastly, it is extremely important to identify and review any funding conditions required by the lender. Things such as valuations, requiring a quantity surveyor to be appointed to the project, or requiring pre-sales may seem appear to be standard funding conditions for development loans, however, each one comes at a specific cost which should be considered.
No matter the structure, it is always best to find a lender that is fully transparent with their clients as to what costs are involved. And remember: “Price is what you pay, value is what you get”.
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From property development loans to bridging loans, ASAP Finance offers a bespoke funding solutions that enable you to get your next project out of the ground. All of our lending managers have development experience, so we understand how important it is to be upfront and transparent with our fee structures.
Start your journey to a completed project, and don’t deal with hurdles along the way. Reach out to an ASAP Finance lending manager today.