As a broker, one of the most challenging loans to put together for a client is a construction loan. This is because of the many elements of the deal that need to be collected and evaluated before a loan is signed off.
As defined by Investopedia:
"A construction loan is a short-term loan used to finance the building or renovation of a home or real estate project."
In our experience, we typically lend to investors who are building one or more dwellings on a residential site, however these loans can be taken out by anyone from an experienced professional developer to an individual who is subdividing their existing property.
The next time a complex construction loan lands on your desk, we'd highly recommend pulling together as much of the following information and passing it on to our Southern Cross Partners team, so we're able to evaluate whether we can provide a loan to help your client quickly and efficiently.
Without further ado, here's how best advice on how to put together a proposal for a construction loan.
1. Tell us who they are and what they are doing
The very first thing we need is to know who they are and what they are trying to achieve, so a completed application form with their statement of position filled out is a great starting point. You can use yours or download one of ours from our website, just ensure its fully completed and signed.
Next, tell us what they are trying to achieve through a diary note.
A comprehensive diary note, laying out the details of the security, build costs, supporting documentation available etc is extremely beneficial to you and to us to clearly see the whole picture.
It can be very helpful in your diary note to cover the following;
a. The Construction History
Something else we take into consideration is whether the borrower has had any experience in construction or development before the point of application. Have they recently built residential property or developments in other similar areas? Were they able to successfully carry out the construction process from end-to-end previously?
Any information you can include in the application on recent projects your client has completed. or if this is their first construction project. will give us an idea of their level of experience, competency, and ultimately help us to assess risk.
b. The Builder History
As with any construction, the builder is a key player that the project hinges on. With that in mind, we always look into which builder you client will be using, whether they have completed projects similar to the proposal and what is their building process like?
We always look for:
- Whether the builder is a Master Builder
- Whether the builder is a New Zealand Certified Builder
At the end of the day, your client is borrowing money to pay to the people who are building the property, so it's essential to determine that the money we are lending is going to be used to build a quality product that abides by construction laws, and these checks help us to verify this.
Usually, we avoid owner builders:
We prefer to use registered builders independent from the borrowers. This is because if something goes wrong with the initial building company, we can always transfer the project to another builder for a similar cost as initially quoted and complete the job.
In the instance of owner builders (ie. the same party that takes out the loan, actually completing the construction work), often wage costs aren't factored in, which means that if something went wrong and the owner builder could no longer work on the project, there wouldn't be enough money to hire a builder and complete the construction, which is a risk.
We also require the Builders Risk Insurance to safeguard and cover any losses if during the project anything goes wrong. Having Southern Cross Partners listed as an interested party on the policy ensures we are able to claim in this circumstance and get the project completed.
2. Construction Costs
In New Zealand, there are a number of ways that builders can quote a construction job. In an ideal situation, we prefer what's called a 'fixed-price' contract. This is defined, as the name suggests, as when your client and the builder agree on the total cost of the building based on your plans and the site, reducing the risk of overruns.
This is extremely valuable, as it helps us to define the end value of the project, what the security will be worth upon completion of the build, and calculate the LVR correctly, ensuring we accurately assess whether we are lending too much or not enough.
Usually, we try to avoid cost-plus contracts, which is when a job cost is drawn up as the project continues and each stage is complete, based on how much each stage costs to complete. This means that there is a possibility that the cost of the construction loan will blow out - and we don't want your clients to get part-way through the construction process and be left short.
Note: We provide construction loan funds to the builder as stages are completed, for example if the builder notifies us that the slab is down, we will then pay the invoice to the builder once we have been notified that the job is completed to a good standard. We may do site visits to ensure that everything is on track and check in on how we expect it to look. We do on occasion pay a lump sum if there is a high standard of both equity and history.
Providing the construction contract with the application is preferred and could help get the application approved quickly along with…
3. Relevant Resource Consent
Ideally, the construction loan will be for a project that already has Council Resource Consent and Building Consents approved.
This means that the construction will meet all obligations defined by their local council body, is safe to complete, and in the future can be resold, potentially subdivided further and if necessary, alterations to the building can be made without running into any issues.
4. The Borrower's Background and Credit Rating
Once we have provided an offer of finance that your borrower has accepted, the last piece of the approval process is a check of your client's background information and credit rating. We do this by running a full credit check through Centrix, the credit bureau of New Zealand. This credit report provides a full breakdown outlining the potential borrowers financial history, including:
- Who they have applied for finance from in the recent past
- Any loans they have defaulted on with other companies, when they were and for how much
- Companies they may be affiliated with (directorship) and any insolvency records
- A credit score that provides a snapshot of an individual’s creditworthiness – the lower the number, the higher the risk
We'll also look into their financial history and get an understanding of where they're at in life - we understand that sometimes a blimp on a credit score can be easily explained, and we always seek to understand the full story before making a decision.
If you're not sure whether your client will be a good fit, we recently wrote a full breakdown of all of the elements our experienced credit check team will assess before approving a loan, which you can read here. But for the most part, we'll take care of this on our end, so if you're not sure, send your client's details through regardless and we'll look into the whole picture before making a decision.
The dream state?
Ideally, we'd love for a broker to present a construction loan, that covers all of these individual aspects, on day one - this is the fastest way to get a loan across the line.
In saying that, we appreciate that these deals are complex, and sometimes not every piece of information will be available, or perhaps you'll be unclear on what specifically you need to ask your client to provide.
In these instances, we'd always encourage you to get in touch - we're here to help. We'll help you to assess the information you have available, and wok with you to figure out what you need to acquire before we can take a look at the loan.
Don't refer the deal to another broker or let the deal walk out the door - get in touch with our team to see how we can help, click below!
