Minimising risk through a structured approach to self-build lending.
Article by Simon Middleton – June 2011
Self-Build lending is still perceived to be problematic even though it’s one of the largest home building sectors in the UK, ultimately delivering prime market property portfolios. Issues of planning problems both prior to and during the build project, restrictive covenants, in addition to the usual income and accident related issues and the very nature of the project being undertaken continue to make lenders wary. But that’s not surprising when You consider the rather bespoke requirements of self-build lending are normally shoe horned into the existing home purchase structured product arrangement which relies on the valuation process and doesn’t really provide a thorough risk management approach.
Traditionally self-build customers are released funds based on a series of stage payment mortgages which are valued at stages by the lenders valuation surveyor. Whilst a valuer has good understanding of the construction process and is absolutely key to assessing anticipated final value, they may not have a full understanding of MMC and Ecobuild systems, or how to assess the property for compliance relative to planning permission and building regulations. It is very difficult for a valuation surveyor to provide the stage valuation the Lenders are relying on especially as the stage reached may not be relevant to the actual expenditure made. More importantly it doesn’t control what the self-builder is spending funds on.
A general lack of understanding by the self-builder and the lender of the requirements at this level means that contracts between the self-builder and their contractors or tradesmen are not always used, which increases the risk of the build going over budget and they don’t always utilise Site Insurance or a 10 Year Structural Warranty, all of which can easily be stipulated. For example:- Self–Build Zone have a contract service which caters for the creation of written legal contracts for the whole project and is less than £50.
To provide that increased degree of comfort to lenders then maybe they should be taking a more bespoke approach to lending into the sector as it seems to me that there are already the tools in place with which to adequately risk manage the construction process, it’s just a matter of implementing a standard framework and sorting out the communication between the various tools.
The pre-build process needs to accurately check the self-builders proposed project and effectively manage the whole process to ensure that adequate measures are in place to safeguard the investment. Ultimately, all parties will benefit.
Check to ensure:-
- Planning Consent: Being valid.
- Defective title: In respect of easements, rights of way, or other restrictive covenants have been suitably assessed and adequate arrangements made.
- Personal Risk Management: In respect of Accident, Sickness and Unemployment; adequate cover should be in place.
- The creation of a stage release Anticipated Budget based on anticipated expenditure. This should be split into key elements which could be recorded as a build Schedule to ensure the project is carried out in the most financially viable way.
- Each key element of the Anticipated Budget is then put out to tender to the self-builders chosen suppliers and contractors with specific contract requirement. This controls the implementation of contracts to protect all parties’ interests and the quoted costs are then checked against budget. The tendering process needs to be done in advance of a Final Build Budget being accepted for lending purposes. Clearly some rules need to be implemented but effectively the prices from the winning contractors/suppliers becomes the Final Build Budget. Assuming this still meets the Lenders acceptance, the work flow and budgeted expenditure is then put together in a Build Budget Schedule the key elements and financial releases of which become the Key Build Elements for inspection. At this point the mortgage goes live and the winning contracts are all signed.
- The schedule is then assessed during the build by :-
- The Mortgagee; who is responsible for plotting progress on the Build Budget Schedule. As the contracts are in place the contractor/supplier will know what has to be completed before they will be paid.
- The Contractors/tradesmen; should be able to see which trades are reliant on each other and be able to quickly identify what needs to be done to complete a key element and therefore secure payment. This should make the job run more efficiently.
- The Structural Warranty Surveyor who in addition to checking Design against planning consent, the placement of the structure and quality of work will confirm when key elements have been completed independently for stage release. They can also carry out the building control function instead of the local authority ultimately improving communication and reducing the impact of having a Valuer, Warranty Auditor and Building Control inspector to just one single party.
- A specialist packager like Buildstore who are responsible for tracking and releasing payment directly to the trades/self-builder on the basis of the customers confirmation of work implemented via their Build Budget Schedule and the Structural Warranty Surveyors confirmation of the Key Elements (which correspond to staged milestones)
- This way the job is being independently assessed for being on track (which I believe is where the risk is) and a packager (like Buildstore) has a clear view if for example a problem starts to manifest and will be able to respond quickly. For example if the builder is not performing to contract the customer could instigate a contract dispute claim (part of the Site Insurance package) remove the builder, instigate a new builder and contract, revise the Final Build Budget, agree an increased loan requirement – but within tolerance and all before a problem manifests.
- Simply relying on a stage valuation does not risk manage the lending process.
If a situation arises which proves to be insurmountable and within the parameter of repossession, the lender will be able to see exactly where the problem has occurred and then push the project through Buildout taking responsibility for ongoing costs which should effectively remain on budget. In theory the lender would not be in a cost overrun scenario as it has been more stringently controlled during the course of the project to date.
If lenders were to consider adopting this (or a similar) standard frame work approach to risk management it would be genuinely deliverable at little or no cost impact.
© Simon Middleton 21st June 2011