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Issues to Consider When Obtaining Construction Finance

Issues to Consider When Obtaining Construction Finance

The general concept of ‘real estate finance’ can cover loans to assist a borrower with the acquisition of a property (whether residential or commercial) or refinancing an existing loan secured against the borrower’s property, loans for the borrower’s business purposes that are secured against property that it owns and loans for the development or construction of property.


Borrowing against an existing property (that has already been built) will, in broad terms, follow standard(ish) legal steps with which many homeowners are familiar, to provide security to a lender. Generally, there will be some form of loan agreement that imposes on the borrower certain financial obligations (i.e. obligations to pay interest and repay the loan sum that was lent) and property obligations (to take steps to maintain the value of the property throughout the duration of the loan agreement, e.g. by requiring the borrower to keep the property in repair, to insure the property, not to cause or permit damage to be caused to the property etc.) and the borrower will be required to enter into documents to provide security in favour of the lender (usually a first legal charge/mortgage over the property and sometimes guarantees in favour of the lender). Development Finance can differ from these more familiar real estate finance methods and additional legal steps and documents may be required.


HOW IS DEVELOPMENT FINANCE DIFFERENT FROM A STANDARD LOAN SECURED AGAINST PROPERTY?


‘Development finance’ or ‘construction finance’ involves a lender providing a loan to a borrower for it to develop (i.e. build, extend, renovate or refurbish) a property. It can form part of a loan that is made to also acquire the property that will be developed. The loan is secured against the property (as with other forms of real estate finance) but security will also be given over the developer’s (i.e. the borrower’s) rights under relevant construction documents – e.g. security over rights of the borrower/landowner under the contract with its building contractor to carry out the development and overs its rights under services agreements with other professionals such as the architects and engineers for the construction project – as well as security over the borrower’s rights to proceeds of insurance policies relating to the property and the construction project itself.


COMPREHENSIVE DUE DILIGENCE REQUIREMENTS FOR LENDERS IN PROPERTY DEVELOPMENT PROJECTS


A prudent lender will usually insist on a full due diligence review not only of the property which is being provided as security, but also a full review of the planned development and all construction contracts and the contractors themselves before funding is released to the borrower. The lender will want to review:

  • the value of the property itself, which will be lower while the construction project is being carried out compared to what its value will be when the development has been completed. On a development project that will involve the sale or lease of units on a development (e.g. building a block of apartments), a lender will want to have a clear picture of (and certain controls in respect of) agreements for leases or sales of units that are in place and will be put in place;
  • the experience and skill of the project team (e.g. main building contractor and associated professionals – e.g. architects, structural engineers and other members of the design team) and what levels of professional indemnity insurance they have in place to cover any defects that may arise in their design (and in the case of the main contractor, whether they have sufficient cover to protect against the possible insolvency of any subcontractors or consultants);
  • the costs to complete the design, build and sale of the development (which, together with funding costs, should not exceed the value of the completed development) – often a lender will require its own ‘monitoring surveyor’ or ‘quantity surveyor’ to review the budgets or, as a minimum, they will arrange for their own professionals to ‘sense-check’ the costings;
  • what rights the lender will have if the borrower/developer is unable to complete the development, such that the lender must ‘step in’ and take over the construction project to get it completed.

CONDITIONS PRECEDENT FOR STANDARD REAL ESTATE LOANS


Lenders of ‘standard’ real estate loans (that do not involve construction elements) normally impose numerous conditions precedent (known as ‘CP’s) such as requiring satisfactory reviews of the property title documents, insurance, appropriate consents and authorisations and planning permissions etc. These CPs must be satisfied by the borrower before the lender will make any funds available to the borrower.


CONDITIONS PRECEDENT FOR CONSTRUCTION AND DEVELOPMENT LOANS


The list of CPs for a construction loan/development loan will include all of these ‘usual’ conditions and impose numerous further construction specific conditions, such as requiring sight of signed building contracts, professional appointments, professional indemnity insurance documents and collateral warranties, as well as detailed budgets that have been approved by the lender’s representatives.

It may be that the construction loan will be released in separate tranches when certain phases of the development have been reached, and in that case it may be that there will be CPs that need to be satisfied at each stage of the development process, possibly to be signed off at each stage by the lender’s own monitoring surveyor (who would represent the lender, but whose fees must be paid by the borrower).

It is for these reasons that the various documents required for a development loan will be more detailed and complicated and accordingly they take more time to negotiate and finalise between the parties and their lawyers than would be the case for a loan that does not involve construction elements.


SUMMARY


Development finance or construction finance facilities are complex, and the legal processes can take a long time, involving many legal advisors acting for the borrower, the lender and sometimes for the building contractors as well. At Quastels, we have experienced lawyers in our Finance & Banking, Real Estate and Construction departments who work together as a single team to progress matters for our clients (both borrowers and lenders) as swiftly as possible.

To discuss any of the points raised in this article, please contact Jason Greenberg or fill in the form below.

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New Homes Warranties and The Building Safety Act

New Homes Warranties and The Building Safety Act

The Building Safety Act 2022 has already brought in substantial regulatory reform with regard to building and fire safety, and continues to alter the property development landscape as sections of the Act are progressively brought into force – frequently with little or no warning.

This article focuses on provisions of the Act relating to New Home Warranties which have yet to actually come into force. These will apply to all newly constructed dwellings, and will make build warranties on these mandatory, and extend these to a minimum of 15 years. These changes will have a substantial impact on developers, housebuilders and insurers alike.

WHAT BUILDINGS ARE AFFECTED?

Whilst common in practice and generally a prerequisite to obtaining mortgage finance, new home warranties have not previously been mandated by law. Where provided, these are typically provided for a 10 year period – of which 2 years will be covered by the developer or housebuilder, and the remaining 8 by the policy provider.

Under section 144 of the BSA, any person carrying out a development in England which results in the creation of one or more dwellings will now be obligated to provide a new build warranty to anyone acquiring an interest in the dwelling, for a minimum term of 15 years from the date on which the relevant interest is granted. The extended term reflects the 15-year limitation period envisaged elsewhere in the BSA.

This applies in connection with any building work done that creates a new home, and not just the construction of a new building. So for instance, the conversion of commercial space to residential space would be caught under the regulations.

Once in force, the provisions will apply to any new dwelling sold or transferred from that point onwards. They will not apply retrospectively, meaning that warranties granted before that date will not need to be extended.

WHAT WILL THE NEW WARRANTIES NEED TO COVER?

A new build warranty is defined under section 144 as an arrangement by which:

  1. the developer agrees, in specified circumstances, to remedy either specified defects or any defect in the dwelling that occurs within a specified period following completion of the build, and
  2. a prescribed person obtains the benefit of a policy covering either specified defects or any defects in the build.

The Act also grants the Secretary of State powers to impose minimum requirements for such warranties by regulation. These are likely to include requirements as to the solvency of any insurer or underwriter, the assignability of the warranty, what defects must be specified, what levels of cover must be provided and even maximum amounts for any excess – but these details have yet to be confirmed. Whether the developer’s specified period of liability will be extended also remains to be seen.

WHAT ARE THE PENALTIES FOR FAILING TO COMPLY?

Once in force, it will be unlawful for developers of a new build home to sell it without providing a 15 year warranty, failing which penalties will apply. The Secretary of State will set out the exact level of financial penalties that could be levied.

At present, section 145 provides that the maximum level of any penalty set will not exceed £10,000 or 10% of the sale price (whichever is the greater). The legislation also states that developers who have a “reasonable excuse” for failing to take out the warranty may not have to pay a fine. What constitutes a “reasonable excuse” has not yet been defined.

Interestingly, the standard of proof to which developers will be held in evidencing that they have a “reasonable excuse” will be the criminal standard – they will have to demonstrate this beyond reasonable doubt.

WHEN ARE THE PROVISIONS LIKELY TO COME INTO FORCE?

The government has stated that it intends to consult widely on the proposed minimum standards, and that it intends to delay commencement of section 144 to allow industry the opportunity to consider the outcome of that consultation. The relevant consultation has yet to be published, and no clear announcement has been made as to when such legislation will be triggered. Whilst Government originally published guidance on new build warranties, this was withdrawn in July 2022, and no further guidance has been published since.

That being said, these changes are inevitably on the horizon, and developers and housebuilders must start to prepare.

HOW CAN DEVELOPERS PREPARE?

Property developers should begin engaging with their warranty providers now, particularly if any agreements with them are being renewed, and they should also budget any consequent increase in insurance premiums into their development costs. Given the length of time the policy must cover, an A-rated insurer will be required to back any such warranties.

To discuss any of the points raised in this article, please contact Stephanie Houston or fill in the form below.

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Building Safety Act 2022: New Regulations For Higher-Risk Buildings

As most of you will know, in August 2023 the Government laid before Parliament several regulations designed to extensively update and change various sections of the Building Safety Act (BSA) 2022 as well as other building regulations.

These changes came into force over the weekend. We have all heard plenty about the intentions behind the new regulations in wake of the Grenfell tragedy and Dame Hackitt’s subsequent report, but what does this mean for you and your business in practice? This article provides a brief overview of the changes.

WHAT ARE THE NEW BUILDING SAFETY REGULATIONS?

The new regulations are:

Alongside the tabling of the new regulations, the Government also published its response to the consultation on changes to the building control regime under the Building Safety Act 2022 (BSA 2022) and relevant regulations.

These changes focused on HRBs and with the Government emphasising that it intended to place additional requirements on all those working on such buildings.

WHAT ARE THE CHANGES THAT CAME INTO FORCE ON 1 OCTOBER 2023?

Part 2A of the Building Regulations etc. (Amendment) (England) Regulations 2023 introduces new dutyholder and competence requirements for practitioners and clients. These apply to all works that are subject to the Building Regulations 2010. Clients are required to plan, manage, and monitor the project to ensure full compliance with the Building Regulations 2010. Designers and contractors should only be appointed once the client is fully satisfied that they meet the competency requirements.

For their part, designers and contractors , having considered the project, must be sure that they can satisfy the competency requirements before they accept the job. Principal designers and principal contractors who have an active co-ordinating role must meet additional requirements before being appointed or accepting an appointment.

To meet the competency requirements, an individual contractor or designer must have the skills, knowledge, experience, and behaviours necessary to fulfil their duties. Entities must have the organisational capability to undertake the project.

Although most of these requirements will have already been fulfilled by the parties, the amendments require the steps be documented so a detailed audit trail exists.

THE BUILDING REGULATIONS ETC. (AMENDMENT) (ENGLAND) REGULATIONS 2023 ALSO PROVIDE FOR:

  • Amendments concerning the process for building control approval in respect of non-Higher-Risk Building works. This replaces the current “deposit of plans”;
  • A more robust definition of “commencement” (which was previously only dealt with in guidance) and provision for the automatic lapse of building control approval after three years if works have not begun; and
  • For building works where the Fire Safety Order applies, the provisions concerning fire safety information have been strengthened.

The changes around HRBs set out in the Building (Higher-Risk Buildings Procedures) (England) Regulations 2023 are in line with those featured in the consultation on which the Government has recently published its responses. They include:

  • At Gateway 2 (building control application stage) and Gateway 3 (completion certificate stage), full details of the compliance documentation to be submitted must be provided.
  • Certain changes to approved documents must be notified to the Building Safety Regulator (BSR). Major changes to the documents will require BSR approval.
  • A mandatory safety reporting procedure for major incidents.
  • A requirement to maintain a golden thread of information in an electronic facility incorporating all approved documents from Gateways 1 and 2, the change control log, any mandatory occurrence reports, any notified changes in the principal designer or principal contractor and a draft Gateway 3. An additional requirement is that this data must be capable of being transferred in a format which is uncorrupted, readable, and intelligible to intended recipients.

TIMESCALES FOR IMPLEMENTATION?

Broadly speaking, the amendments to the Building Regulations 2010 and the Approved Inspectors Regulations 2010 will not apply to building work started or where an initial notice has been given to a local authority and was accepted or treated as accepted before 1 October 2023.

There are complex transitional provisions in relation to the Higher-Risk Buildings Procedures Regulations 2023 which are beyond the scope of this article. If you have any questions, please feel free to contact me.

WRAPPING UP

Many of the questions relating to the changes to the building safety regime will only become apparent as the new provisions bed in.

However, we do expect Regulators and the Courts to take a hard line on any breaches, so it is vital that your business fully grasps the changes and implements policies and procedures to ensure compliance.

To discuss any of the points raised in this article, please contact Stephanie Houston or fill in the form below.

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