Risks

Interest rates have recently started to rise from their current historic low levels. The magnitude of any future rises and where rates will settle is uncertain, but the increase in interest payable could adversely affect the borrower's cash flow. Moreover, interest rate rises also impact the housing market by dampening demand from home buyers and potentially leading to a fall in values.

For this reason, the CapitalStackers due diligence process examines the sensitivity of the borrower's cash flow, including increases in interest payments and lengthening sales periods. These sensitivities are shared in the financial reports.

Capitalstackers will procure an independent property valuation before any funds are advanced. Where the senior lender is also seeking an independent valuation, an instruction for a joint valuation will be sought.

Financial sensitivities will be run in line with the valuation findings.

The CapitalStackers due diligence process requires formal meetings with the borrower and an inspection of the property to be funded. A thorough assessment of the proposal, the borrower's background and the source of their equity contribution is checked against their business plan and the senior debt terms and conditions.

Where possible, we insist on construction subject to a fixed price, design and build contract although in some cases a construction management solution may be wholly acceptable. In all cases we ensure there’s an acceptable contingency fund in the development cashflow to cover any unexpected cost overruns (arising from, for example, inclement weather or adverse ground conditions). Where necessary, we seek third party guarantees for additional funds to be injected in the event of a cost overrun.

CapitalStackers will appoint an independent Monitoring Surveyor to oversee the progress of a project and produce monthly reports, which will be shared with investors via the data room. Reports will specifically comment on progress against budget and the estimated cost to complete the development.

The Monitoring Surveyor may be appointed jointly with the senior lender.

The Monitoring Surveyor reports monthly on progress against budgeted costs and timescales and will highlight any delay or potential delay. We remain in constant touch with the borrower throughout the development, and keep investors fully informed via the deal data room.

As part of their initial report, the valuer will provide commentary on the budgeted sales programme, and our financial analysis will include a sensitivity of these anticipated timings. Any variances to the build period highlighted by the Monitoring Surveyor will be discussed with the borrower during the development and trigger further sensitivity analysis.

To assess the impact of a potential delay in sales or fall in value, sensitivities on both adverse price and time delays will be included in the initial analysis and presented to investors and for illustrative purposes compared to the borrower's base case.

Senior debt is repaid in priority to junior debt. Senior debt can increase above the level initially appraised for a number of reasons. These include the funding of cost overruns, the charging of additional fees or the charging of default interest. All these have the potential to “squeeze” the junior debt position, particularly when allied with falling property values and/or an extended development or sales period.

Or, rather, lack of liquidity, can impact development lending where it is necessary to pay monthy construction certificates. Failure to pay the contractor on time will result in the site closing down, choking off the ability to complete the build. And it's highly unlikely a buyer can be found for a part-complete site at a price sufficient to repay all outstanding funding. Consequently, we only partner with banks and debt funds that are able to demonstrate their ability to fund the deal through to, and beyond, Practical Completion.

A senior lender has only the senior lender's interests at heart. We might have some leverage to influence decision making but when it comes to the crunch the senior lender will undoubtedly protect its own position, potentially at the expense of the junior lender. This could mean financing cost overruns which would push the junior debt higher up the risk curve or the unilateral appointment of an LPA Receiver or Administrator against our wishes.