South African developers looking to obtain finance to build and sell, or to build and hold and rent out, such as townhouse complexes, flats or retirement developments, are struggling to acquire funding from banks.
This is according to Gary Palmer, CEO of Paragon Lending Solutions, who said that owing 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 presales for the transactions where developers are looking to build and sell to third 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 residential leases are typically signed for 12 months only.
Palmer said that after the economic recession the South African property market shifted its property investment preference from residential to commercial property, the latter being a safer and more lucrative investment at the time. He said that over the past few years the market had shifted back to residential property as the demand for residential rentals had been 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 because of 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 also being achieved.”
Palmer explained that most South African lenders require pre-sale agreements to be in place when dealing with residential development finance. Such contracts state that the property in question must be sold before a developer’s loan is paid out. They give lenders the assurance that the developer will have the capital available to repay the loan taken to develop the property. Banks often require a condition of 120% pre-sale requirement, which, Palmer believes, is unrealistic and difficult for developers to obtain.
Another reason banks don’t often approve loans to developers for residential property in South Africa is that in the past, developers were unable to sell the units that had already been developed, leaving the bank with an incomplete building to pay off. “This concerns banks the most,” said Palmer.
Palmer said that developers who are struggling to obtain bank funding could consider nonbank lenders that provide short-term, asset-backed funding secured against residential, office, industrial and retail properties. “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.”