What has changed and how it may affect you

Prior to this year NZ experienced a sustained period of historically low interest rates and a bounding residential property market. Securing commercial property and/or development finance in that environment had been relatively easy as market conditions meant that many of the key bank criteria were easier to meet. However, this year has seen interest rates rise significantly, residential property values decrease, yields on some commercial properties soften, and demand for pre-sales in residential developments fall considerably.

On top of that, the Reserve Bank’s new capital adequacy framework has quietly come into play. The new framework increases the amount of capital banks must have. Increases in capital are being phased in over a 7-year period that started in July this year. What each bank needs to do to hit its target will vary from bank to bank, as will the means and strategies they employ to get there. However, a tighter availability of credit and a reduced appetite for risk will likely be among those strategies.

All of this means that borrowers may now be finding it harder to secure bank funding for development projects, commercial property purchases or even to rollover existing loans, on the terms or at the levels expected.

Some of the things that borrowers may now be encountering with banks could include:

• For commercial property loans;
  • As values fall, so does the amount that can be borrowed. On existing loans with loan to value (LVR) covenants, new valuations may be required. In some instances, LVR covenants may come under pressure.
  • As interest rates increase, the level of debt that rents can support decreases. The ‘test’ rates banks were using 1 year ago are probably now the actual rates. The debt servicing tests that the banks run will be harder to meet without reducing the amount borrowed or finding more income to support it. On existing loans with interest cover covenants, those covenants may come under pressure.
  • At higher debt levels, more aggressive repayments of principal may be required.

• For residential development loans;
  • Higher levels of presales may be required. Other pre-sale criteria may have also tightened up.
  • More scrutiny about the deals they chose to do, including less willingness to support inexperienced developers.

However, banks will always be happy to fund good deals, particularly those with sound fundamentals and that are well presented to them.

The key message here is that, in the current environment, it will pay to be prepared. Get all your ducks in a row before going to the bank. The aim should be to make the deal as clean and as easy as possible for the bank to consider.

That could mean:

• For commercial property financing - Make sure leases are tidy. Deeds of lease and any renewals of lease are all in place. The longer the average lease expiry profile of the property, the more appealing that will be to the bank. Make sure that any rent reviews that have come around have been completed. Any rental growth that can be achieved will help the debt servicing equation, and along with longer average lease expiry profiles, will also improve a property’s value. Make sure financials are up to date. Consider obtaining an updated valuation. The bank may need it, even for an existing loan. If you do, make sure the valuation is completed by a valuer that is acceptable to the bank.

• For development financing - Check what the banks requirements are before starting. Then try to provide what they need, including all consents, costings and professional reports (engineering, QS, valuation, etc) for the development. In terms of pre-sales, find out what percentage of pre-sale cover they will require, and what the banks ‘qualifying’ pre-sale criteria are. This will include things like the minimum deposits they require, minimum sunset dates lengths, and limits on the number of sales they will allow to buyers of more than one unit/section in the development. Prepare a schedule of sales, including the key details the bank requires. Be prepared to provide well-constructed and correctly executed pre-sale agreements. The bank may require their own lawyer to review and approve them.

By understanding what banks require, and ticking the boxes, the deal will be more attractive and easier for the bank to approve. In the current environment, where some banks may be more selective over the deals that cross their desks, that may prove to be critically important.

That’s not to say there aren’t other options out there. We have started to see an increase in ‘non-bank lender’ loan instructions crossing our desks. For various reasons, including easier credit criteria or more flexible conditions, these are preferred by some borrowers, even though they are typically more expensive and are for a shorter duration.

Cavell Leitch’s property experts have considerable experience helping clients with their commercial property and/or development financing needs. We have developed strong relationships with all the major banks and can work with you and your lender to help get deals across the line.