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Development Finance: How Do Banks Assess Their Risk In This Form Of Lending?

In the real estate development sector, financing plays a pivotal role in allowing developers to deliver ambitious development projects. Traditional lending practices often focus solely on the bricks and mortar value of a project. However, a more innovative approach in the industry involves lending against a percentage of the Gross Development Value (GDV). This shift in perspective reflects a deeper understanding of the inherent risks and opportunities in development projects. In this article, we delve into the concept of development funding based on GDV and explore how banks assess and mitigate risks associated with such loans.



Understanding Development Funding Based on GDV

 

Development funding based on GDV refers to a financing approach where banks lend against a percentage of the projected GDV of a development project, rather than relying solely on the current value of the physical assets involved. GDV represents the anticipated worth of a completed development, factoring in market demand, location attractiveness, and other relevant variables.

 

This approach allows developers to access funding that is more closely aligned with the potential value of their project upon completion, rather than being constrained by the current value of the land or existing structures. By leveraging GDV, developers can secure the necessary capital to undertake ambitious projects and maximise their potential returns.

 

Assessing Risk in Development Loans

 

Banks assess the risk associated with development loans through a comprehensive evaluation process that takes into account various factors:

 

  1. Market Analysis: Banks analyse market trends, demand-supply dynamics, and economic indicators to gauge the viability of a development project. A robust market outlook enhances the likelihood of project success.  

  2. Project Feasibility: Evaluating the feasibility of the project involves assessing its design, scope, and cost structure. Banks scrutinise the developer's plans to ensure they are realistic and aligned with market demands.  

  3. Developer Track Record: The track record of the developer plays a crucial role in risk assessment. Banks prefer to work with experienced developers who have a proven history of successful projects, as this reduces the likelihood of delays or cost overruns.  

  4. Exit Strategy: Banks examine the developer's exit strategy, which outlines how they intend to repay the loan upon project completion. A well-defined exit strategy mitigates the risk of default and provides assurance to the lender.  

  5. Collateral: While GDV-based lending focuses on future value, banks still require collateral to secure the loan. This often includes the underlying land, development rights, or other assets owned by the developer.

 

By carefully evaluating these factors, banks can effectively manage the risks associated with development loans and make informed lending decisions that align with their risk appetite and strategic objectives.

 

In conclusion, development funding based on GDV represents a progressive approach to real estate financing that aligns more closely with the potential value of a project. By understanding and mitigating the risks associated with such loans, banks can support developers in bringing innovative projects to fruition, driving growth and transformation in the real estate sector.

 

Q&A: Common Industry Terms

 

  1. What is Gross Development Value (GDV)? The anticipated value of a development project upon completion, taking into account market factors and demand.

  2. What is Bricks and Mortar Value? The current value of the physical assets involved in a development project, typically referring to land and existing structures.

  3. What is a Risk Assessment? The process of evaluating the potential risks associated with a financial transaction or investment, including market risk, credit risk, and operational risk.

  4. What is an Exit Strategy? A plan outlining how a borrower intends to repay a loan or exit an investment, often through the sale or refinancing of assets.

  5. What is Collateral? Assets pledged by a borrower to secure a loan, providing assurance to the lender in the event of default.

 

Enquiries

 

For further information, please contact info@langdoncap.com 

 

About the author

 

Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of debt, equity, M&A and derivatives transactions with global corporates, private equity funds and financial sponsor groups.

 

About Langdon Capital

 

Langdon Capital assists SMEs and mid-market companies with capital raising, M&A and disposals up to £250m in transaction size; and innovative, high-growth companies with >£1m in annual revenue and >30% in annual revenue growth raise debt or equity, at Series A and later funding rounds, from a network of alternative investors spanning private equity firms, venture capital funds, corporate VC arms, family offices, venture debt funds, private credit funds, real estate funds and hedge funds.

 

 

 

This is not financial advice or any offer, invitation or inducement to sell or provide financial products or services or to engage in any form of investment activity.

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