Independent economist and former BNZ chief economist Tony Alexander recently said New Zealand's “explosive growth” in construction was unsustainable. In fact, the industry had already entered the downturn phase of its cycle and faced mounting crises.
New Zealand Building Industry Federation chief executive Julien Leys also pointed out that supply chain problems, rising labour costs and cash flow pressures were together creating the industry's current predicament. Shortages of building materials and labour were delaying projects, significantly affecting developers and builders. Several banks, including ANZ, had raised construction loan interest rates and tightened lending further. Falling house prices since the start of the year had compounded the industry's difficulties.
Small and medium-sized construction companies, which account for 20% of the market, are bearing the brunt. Their comparatively weaker materials procurement channels, bargaining power and storage capacity mean they are more likely to face missed completion deadlines, penalties and even cash flow failure. Indeed, in just the first few months of this year, up to 23 May, 92 New Zealand construction companies had already entered liquidation.
Yet as a winter of hardship approaches for the construction industry, one medium-sized developer and builder says: “I've finally made it through!” How did he manage it? Finance expert and former central government investment official Vicky Xi shares a true story that may offer some inspiration to fellow small and medium-sized developers and builders.
About Vicky
Vicky Xi, a financing partner at Golden Squirrel Group, has nearly a decade of local banking experience in New Zealand and previously served as the New Zealand Government's director of cross-border investment for Greater China.(Click to read “Daunted by an unfamiliar industry? A former New Zealand government investment official helps your financing take flight!”)
With extensive experience in New Zealand's financial system and a thorough understanding of the financing and lending rules used by major commercial banks' property divisions and finance companies, Vicky has considerable expertise in development-related lending, including land purchase, development and construction loans. YIJU has teamed up with Vicky to launch the “Expert Spotlight: Financing” column. Through in-depth analysis of representative cases, it aims to share the financing insights Vicky has distilled from years of practical experience with YIJU readers, helping them apply those lessons to other situations.
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Case study
Mr L is an experienced developer and builder who started by developing and building standalone homes, steadily growing his company through a “snowball” approach. In recent years, he has begun investing in and building several medium-sized developments of thirty to fifty homes, both independently and through joint ventures. He benefited substantially from the market upswing over the past year or so, and his business grew rapidly.
Mr L now plans to free up funds and buy land during a quieter market period so he can continue with new projects, but he has encountered a problem. Previously, his projects were funded mainly through company profits and finance company loans. Although their interest rates were slightly higher than banks', they offered less demanding conditions and simpler applications. In the current tight credit environment, however, finance companies' interest rates and fees keep rising, while lending requirements are becoming stricter. In particular, higher equity requirements have forced Mr L to consider borrowing from banks' property divisions, an option he had not previously explored.
Bank finance offers the lowest financing costs for property development, but banks set demanding requirements for developers' credentials and projects. Borrowers need an excellent track record of managing and delivering developments to have a chance of approval. Banks also require borrowers to meet certain pre-sale conditions. Although they release construction loans in stages, commercial banks currently apply very strict approval criteria to builders of all sizes because of uncertainties around development management costs, long capital recovery periods and relatively low profits in the current market.
L’s difficulties in applying for a bank loan lay precisely here:
Previously, Mr L had used bank cash flow loans and investment property loans, but had never successfully secured a loan from a bank's property division. A very low-profile person, he had no company website or promotional materials, and his team believed in keeping things simple. As both developer and builder, he also had no main construction contract to support the application and no experience dealing with a quantity surveyor (QS).
Fortunately, Mr L met Vicky.
Professional advice
During a credit squeeze, the stability of funding for a project's later stages is particularly important. For medium and large projects, which involve long timeframes and substantial sums, relatively stable funding channels are advisable. Commercial banks and large finance companies with good reputations are worthwhile options. It is also important to look beyond whether a loan has been “approved” and pay close attention to the terms and details governing the release of funds.
Banks have higher entry requirements than finance companies. Once a banking relationship is established, however, conditions gradually ease, while interest rates and related fees can be low enough to make borrowers feel that “daylight has finally arrived” and they have “made it through”.
Vicky has established good working relationships with the property divisions of major commercial banks and knows their financing and lending rules well. Through detailed, efficient discussions with Mr L, she helped him overcome the many obstacles and obtain a credit committee-approved letter of intent for a loan within a week. The interest rate was similar to a home loan rate and only half the finance company's rate; the bank application fee was 1%; and the loan covered almost 95% of project costs, including land purchase, construction, consultants and marketing. Only NZ$1,000,000 of his own funds was required, with pre-tax profit roughly estimated at NZ$5,000,000. Vicky also drew on Golden Squirrel Group's influence to select a QS and arrange discussions, facilitating project cost assessments and the release of funds.
Reflecting on Vicky's “impressive results”, Mr L said:
He felt completely reassured and could even say he had never worried, because he had an “outstanding”, “dedicated” adviser. “I've also learnt a lot from Vicky's market analysis and wealth of experience. Property development depends on teamwork. If you find reliable people to lead each stage, the developer can free themselves from the day-to-day demands of the development business!”
One point deserves particular attention: unlike last year's market, longer pre-sale periods now demand greater coordination and planning from developers. Every stage is interconnected. Seeking out experienced, trusted advisers early to understand the market and explore solutions allows developers to plan ahead and be prepared.