Lender considerations in part-built development recoveries

In our previous article, we explored the impact of incomplete development sites on lenders. We continue to see property developers face unfavourable market conditions, leading to business failures and lenders needing to recover their investments from challenging part-built developments. In this article, we’ll delve into the key issues that need to be considered when a lender is forced to crystallise their position in relation to a part-built development.

Which market factors are still affecting lenders?

The key factors we discussed in our previous article remain the root cause of difficulties for developers. Here is an overview:

• Interest rates have been high compared to the last 15 years, resulting in a significant cost of funding and a negative impact on developers’ profit margins.
• Higher mortgage rates, which are reducing the buying power of end users and, therefore, demand.
• High energy, labour and materials prices are also reducing developers’ profit margins.
• Reduced economic activity and continued rising input costs (particularly labour) are causing a continued rise in contractor insolvencies (an update on this is provided below).

In addition to the above, there is also a trend of agents valuing property more cautiously, impacting developers’ Loan-to-Value (LTV) covenants.

What are the issues on crystallisation of security?

Building out

The key consideration when enforcing over a lend secured by a part-built development is whether it will be best to sell the property “as is” or to complete the development and then sell. In most cases, it would seem financially advantageous to build-out. However, this can be challenging, and the practical and financial position should be properly assessed by an insolvency practitioner upfront. Practical considerations, including those listed below, will form part of the considerations.

Securing key information from debtor entities

Obtaining key information such as architects’ drawings, local authority agreements and design information from the debtor entity can be challenging. Working collaboratively with the debtor entity is always preferable. However, consideration should be given to securing information prior to enforcement and, in difficult circumstances, utilising an administration process to enforce cooperation where the debtor is a corporate business.

Continuity of supply

Certain contractors may be key to protecting the value of the underlying asset. Those providing collateral warranties (such as roofers) or certifications (such as electricians) may be crucial. In these cases, understanding the needs of these suppliers early in the process is paramount. This is often an area where meeting outstanding costs is the only way to resolve the position, and this will need to be considered where assessing the options of selling “as is” versus building out.

Continuity of professional support

Professionals such as architects, surveyors and, in particular, building control officers, will be key to any attempt to maximise a property value via build-out. Early engagement is key. It may be advantageous to work with a key employee or director from the debtor company to secure this support.

Prior security and UN1 holders

The lender’s security position should be assessed by a solicitor prior to any enforcement action to understand the order of security priority. For residential apartment blocks where units have been sold “off-plan”, deposits paid can create a form of lien and be secured by UN1s registered at the Land Registry. Depending upon the timing of these registrations, they may rank ahead of the lender.

Impact of high-risk building regulations

Various rules and restrictions may apply to specific property assets and will need to be adhered to as part of any build-out strategy. A topical issue at present is the introduction of the High-Risk Building Provisions (part of the Building Safety Act 2022). This creates greater scrutiny on the development of taller buildings in the wake of the Grenfell Tower disaster. These provisions, rightly, add time and cost to a build-out schedule to ensure high safety standards are met.

Any property situation will have a unique set of circumstances. Therefore, when lending to a developer that is facing financial difficulty, it is important to plan in advance of any enforcement action.

The issues above, among others, need to be carefully considered before seeking to enforce security. This will ensure that major pitfalls are avoided or managed as best as possible, and the optimal outcome is achieved for all stakeholders.

If you would like further information on what would be the best solution for you, please contact Lee Lockwood or Gordon Thomson.