Property Finance Update · Contents © Simpson Grierson 2016 Section Page Introduction.....1 Structuring of a standard property development financing transaction

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© Simpson Grierson 2016

Property Finance Update Conference Paper by Stuart Evans, Partner

November 2016

Contents


Section Page

Introduction ............................................................................................................................................. 1

Structuring of a standard property development financing transaction ................................................. 2

Presales .................................................................................................................................................... 8

What constitutes acceptable terms? ....................................................................................................... 9

Additional representations from Purchasers .........................................................................................12

Disclosure Requirements takings from Developer .................................................................................13

Unit Titles Act 2010 (UTA) disclosure requirements .............................................................................14

Shared funding of infrastructure for Greenfields Development ............................................................16

Topical issues in property financing and 12 month horizon ..................................................................17


Introduction

© Simpson Grierson 2016 1

The property finance market has been very active for several years. There is a huge focus on property in the media. For a long time the media focus has revolved around the large increases in property values and prices, particularly in Auckland, and issues around affordability. While this still remains a large focus, there is more attention being given at present to availability of bank funding and instances of property developments collapsing as a result of increased construction costs. The purpose of this paper is to provide a general overview of the structuring and current requirements of property development funding, with a particular focus on availability of funding, deeds of priority, direct agreements with contractors and presale requirements, and to also consider current topical issues in the property financing area and what we may expect to see over the next 12 months or so. From a lawyer's perspective, the area of property finance is very contract based with a focus on drafting and negotiating the relevant documentation relating to the financing and dealing with the relevant conditions that need to be satisfied for that financing to be made available. Accordingly, this paper has a "practical" basis to it.

Stuart Evans, Partner Banking & Finance DDI: +64 9 977 5321 Mobile: +64 21 633 422 [email protected]

1 Structuring of a standard property development financing transaction


A standard property development financing transaction under which a financier provides funding for the development of residential properties will generally comprise of the following transaction documents:

FACILITY AGREEMENT: A LOAN FACILITY AGREEMENT

This will generally comprise of several different tranches to fund the refinance of the initial purchase of the land; development costs; and separately the GST payable on development costs. An establishment fee will generally be payable, and often a line fee will be payable on the undrawn commitment on a monthly or quarterly basis. Interest and fees will generally be capitalised to the loan and repayable on expiry (given the developer will not be receiving any income from the development to service its funding costs until the development is completed and properties are sold). The developer will be required to apply net sale proceeds in repayment of the loan. The main conditions precedent to availability of the loan facility will include:

o a requirement that all necessary equity and mezzanine finance has been injected into the development (generally a bank will provide up to 70-75% of the costs of the development, which has decreased from about 80% previously). Any mezzanine financing will need to be subordinated on terms acceptable to the Bank (see below);

o receipt of an acceptable report from the Bank's quantity surveyor regarding the development and its feasibility. The most important points to be covered off from the financier's perspective are:

• that the development can be completed within the budgetary allowances, time frames and construction programme as advised to the financier. While this has always been important, it is particularly important in the current market where there are a number of developments suffering cost overruns and delays;

• related to the above, a review of the development budget, costs and projected cash flow, the extent to which these are fixed, the adequacy of the contingency (which must generally be at least 10% of development costs) and any circumstances which may result in an increase in costs;

• acceptable contractual arrangements being in place, including arrangements relating to retentions and bonds (generally a financier will require that a performance bond is provided on behalf of the contractor from an acceptable party (generally a bank) for about 5% of the contract price and that such bond is assigned to it), progress payments, guarantees (including sub-contractors' continuity guarantees under which they agree to continue performing if the contractor goes under, provided they continue to be paid), liquidated damages for delays, variations and rectification of defects, including verification that the same are appropriate, realistic and reasonable for the nature and scope of the development;

• certification that the key persons engaged to undertake the works and/or provide goods and services have the necessary experience, skills and resources to perform. A financier places a lot of weight on the experience, reputation and past performance of the head contractor particularly, especially in the current

1 Structuring of a standard property development financing transaction - continued


market where contractors are taking on a lot of work;

• that all necessary building and resource consents necessary to undertake the development have been granted and that the associated conditions and requirements imposed can be satisfied; and

• verification that the construction contract, consents and plans are consistent with the developer's contractual obligations under presales, and the valuation relied on by the financier.

o an acceptable level of presales (see below).

Conditions precedent to each advance being made under the facility. The most important of these will require that:

o advances made to fund development costs are made on a "cost to complete basis" following receipt by the financier of a progress certificate from the Quantity Surveyor, certifying as to:

• the total costs incurred, the intended application of the advance, amounts previously claimed/paid, retentions held, variations, use of contingency and the cost to complete the development;

• the costs incurred being properly payable and that the cost to complete the development can be funded by the balance available under the facility;

• the works being carried out in accordance with the construction budget and programme, and in compliance with all relevant regulatory requirements;

• any variations or potential variations to the construction contract and any risks to budgeted costs and projected practical completion dates of the development;

• any problems or disputes in respect of the development;

• all previous contractor, sub-contractor and supplier claims having been paid; and

• that all necessary insurances remain in place.

Development specific covenants, including the following:

o that any cost overruns must be met from the developer's own resources;

o that the financier is notified of any breaches or disputes under the construction contract;

o that the construction programme does not fall more than four weeks behind the programme confirmed by the QS;

o that no material amendments are made to any construction documentation and it will not agree to any variations under the construction contract exceeding certain agreed amounts, on a single or cumulative basis;

o that the developer will, upon request by the bank, take all action necessary to enforce the terms of the construction contract and not replace the contractor without the bank's prior consent;

o that it will provide the bank with a code compliance certificate for the development within a reasonable period following practical completion;

o that it will not extend any timeframes or milestone dates specified in the construction programme nor agree to extend the date for practical completion under the construction contract without the bank's prior consent;

o allowing the bank to attend all project control group meetings;

o that it will deliver each payment claim and payment schedule issued in connection with the construction contract to the QS; and



o restricting the developer from entering into further sales at a value less than, say 10%, below the marketing value for each unit.

MORTGAGE

A mortgage over the property being financed.

GSA

A general security agreement over all assets of the developer. If issues arise in respect of the development then the financier needs to ensure that it can take control of all assets related to the development, including all contractual arrangements entered into by the developer.

GUARANTEES

Personal guarantees from the principal/s behind the developer. Generally speaking, the financier isn't expecting to rely on such guarantees from a credit/security perspective (given the majority of a principal's assets will not generally be personally owned by them) but more from a leverage perspective to the extent that there are issues with the development and the financier requires the principals' co-operation. Obviously, the threat of bankruptcy, and particularly the reputational consequences, can be significant for a principal.

SPECIFIC SECURITY OVER SALE AND PURCHASE AGREEMENTS

A specific security agreement over the developer's right, title and interest in the sale and purchase agreements in respect of the development, including deposits. While the financier will hold security over such assets under its GSA it is market practice for financiers to take specific security over important assets/contractual arrangements. Amongst other things, this emphasises to developers the importance of the relevant assets to the financier. The specific security agreement utilised by the financier will

generally include additional, specific representations and covenants relating to the assets secured than what are contained in their GSA or Mortgage, together with a form of notice of assignment to be executed by the developer and addressed to the purchaser under each agreement and the financier's requirements in respect of when these must be issued to purchasers. Market practice is generally for signed and completed notices to be provided to the financier for holding, pending an event of default occurring or another event occurring which may have an adverse effect on the financier's security position. Generally developers are reluctant for notices of assignment to be issued to purchasers when there are no issues with the development/financing given that unsophisticated or badly advised purchasers may get the impression that there are issues with the developer.

SPECIFIC SECURITY OVER CONSTRUCTION DOCUMENTS

A specific security agreement over the developer's right, title and interest in the construction contract, any performance bond issued in favour of the developer on behalf of the contractor and any documents relating to the development, including plans, designs, specifications and drawings. Such specific security is generally taken by the bank for the same reasons as the specific security over sale and purchase agreements.

DEED OF PRIORITY AND SUBORDINATION

A deed of priority and subordination with any provider of mezzanine financing:

o From a bank's perspective as first mortgagee and senior financier it expects the following:

• the mezzanine financier to be fully subordinated from both a payment and enforcement perspective;

• the bank to have first priority for an amount sufficient to repay its principal



indebtedness (inclusive of provision for capitalised interest and fees) plus 24 months' interest and costs of realisation;

• the mezzanine financier to be prevented from taking any enforcement action without the bank's consent or until the bank has been repaid in full. This is particularly important on a development transaction. If a development is incomplete then the bank expects to be controlling proceedings without interference from the mezzanine financier;

• the mezzanine financier to covenant to act in good faith and co-operate with the bank to ensure the timely completion of the development and the settlement of sales, including the provision of any consents required to complete any subdivision and the release of security to enable the settlement of sales;

• the ability to provide additional debt if required to complete the development, with the bank's priority amount deemed to have increased by a corresponding amount, to ensure that the bank retains first priority for any additional amounts advanced; and

• a power of attorney from the mezzanine financier in favour of the bank, authorising it to do all acts and things necessary or appropriate in connection with completing the development and settling sales.

o Generally speaking, while banks acknowledge that mezzanine finance is often necessary for developments to be undertaken (where the developer doesn't have sufficient equity) the banks are essentially treating the mezzanine debt as equity and don't expect to be dictated to by a mezzanine financier that is earning far higher interest and fees, and therefore expected to take on a commensurate

amount of risk from a financing perspective. Leading up to the Global Financial Crisis (GFC) when there was a huge amount of mezzanine finance being provided by a very active finance company market we saw deeds of priority gradually become more and more favourable to mezzanine financiers with banks making a number of concessions. This caused issues for banks during the GFC when, for example, they had to deal with mezzanine financiers seeking to control enforcement action, refusing to release mortgages to allow settlements to occur without receiving fees etc. As a result we saw deeds of priority revert back to being very "bank friendly" again. However, with the increase in property development lending in recent years and new players coming into the mezzanine finance market, we often see mezzanine financiers seeking additional rights. These include:

• a strict setting of the bank's "nominated amount" within its priority amount, limited to its actual facility limit without an additional amount of "fat" within such amount, with the bank expected to rely on a stricter "further advances' clause if it wishes to, or needs to, advance further amounts in connection with the development, with an expectation that the QS must certify any additional advances as being necessary to complete the development and sell the relevant units;

• no complete restriction on enforcement rights. Mezzanine financiers are wary of banks sitting on defaults and accruing a substantial amount of default interest within the interest component of their priority amount, ahead of the mezzanine financier's debt, without having any rights. Mezzanine financiers sometimes seek the right to take enforcement action if a specified period of time has elapsed since an event of default occurred (say 3 to 6



months) without the bank taking any enforcement action.

• as noted above, it is reasonably standard for a bank's priority amount to include 24 months interest, in addition to its "nominated amount". Related to the previous point, where mezzanine financiers are wary of banks sitting on defaults and accruing default interest ahead of them under their priority amount, mezzanine financiers may seek to limit the amount of "pre-enforcement" interest that may be claimed within the bank's priority amount to say 6 months' worth of interest. While it was common prior to the GFC for banks to agree to this, in my experience they are less receptive at present.

• a right to purchase the bank's debt in certain circumstances and therefore control any enforcement process, or in fact manage the project and any issues so that no enforcement action is required. Mezzanine financiers are concerned that a bank may elect to go down the enforcement path as this may be the quickest and easiest way for them to recover their debt but it may leave the mezzanine financier with a potential shortfall or a greater shortfall than they may otherwise have incurred. As soon as any enforcement process is commenced (even if it is just the issuing of notices under the Property Law Act) word spreads very quickly in the market and this has the potential to reduce values and concern purchasers.

• as noted above, a bank expects a mezzanine financier to covenant to co-operate with the bank in achieving the settlement of sales and to release their security to enable sales to occur. It is important to note that this is relevant to a pre-enforcement scenario, with there obviously being relevant legislation that applies in the case of a

bank exercising its power of sale under its mortgage, with a mortgagee owing a duty of reasonable care to obtain the best price reasonably obtainable as at the time of sale under Section 176 of the Property Law Act 2007 (PLA) and having the right to transfer the property free of any subsequent mortgage under Section 183(4) of the PLA. Mezzanine financiers may seek to require that their covenant to release their security on a sale is conditional upon the sale being at a specific price, consistent with an agreed sales schedule up front or as a percentage (say 80 to 85%) of a registered valuation of the property. In my experience, banks are very resistant to limit their exit rights in such a way.

DIRECT DEED

A deed entered into between the developer, the contractor and the bank. This is variously called a "direct deed", a "step-in deed" or a "tripartite deed". Such deed generally provides for the following:

o An acknowledgment from the contractor that it has been notified of, and consents to, the bank's security over the developer (including its right, title and interest in the construction contract) and that if the bank's security becomes enforceable it may exercise all of the rights of the developer under the construction contract and at the bank's option (but subject to the terms of the direct deed), perform all of the obligations of the developer under the construction contract;

o Agreement from the contractor not to agree to a material variation under the construction contract without the bank's consent;

o An irrevocable authorisation and direction from the developer to the bank to pay directly to the contractor amounts drawn down by the developer under the facility agreement in respect of the construction



contract. From a contractor's perspective, this is generally the biggest advantage to them of entering into a direct deed. They may also seek to get agreement from the bank that if the bank cancels the loan facility then the contractor will be entitled to provide the bank with confirmation of its costs to date (certified by the QS) and the bank will pay them as a drawdown, although banks are generally reluctant to agree to this;

o Agreement from the contractor to notify the bank if any breach occurs under the contract and it intends to take any action in respect of the same and to suspend taking any action while the bank is given a reasonable period of time for itself, a receiver or a nominee of the bank approved by the contractor , to remedy any default or put in place alternative arrangements that are acceptable to the contractor, in order to keep the construction contract on foot. The contractor will expect to be paid during the period that the bank is considering whether to take any action and of course if it or another relevant party chooses to remedy a default. From a bank's perspective it is most often easier and more cost effective to step-in and do what is required to keep the contractor on site and the construction contract on foot than to have to contract a new contractor to finish a development. From a bank's perspective, this is the main reason for putting in place a direct deed. However, in my experience and from a practical perspective, the first person that a contractor will call when there are issues with a developer (generally non-payment) is the bank, notwithstanding whatever contractual arrangements may or may not be in place between the bank and contractor;

o If the contractor is entitled to take default action, a requirement on the developer (if required by the bank) to assign to the bank (or a receiver or other assignee) the benefit of the construction contract and any other agreement for the provision of consultancy services and the supply of services and goods and for the execution of any other works related to the construction contract; and

o Agreement from the bank to notify the contractor of any event of default under the loan facility.

2

Presales


One of the most important conditions to be satisfied for the availability of funding for a property development is an acceptable threshold of qualifying presale agreements. A financier needs to ensure that the developer (its borrower) has a sufficient amount of acceptable, contracted presales to ensure that its debt can be repaid on completion of the development. Generally a financier will require the following to ensure that presales are qualifying:

o Presales with a total aggregate purchase price (excluding GST) of generally 110-120% of the amount being funded for a senior financier. Generally, a mezzanine financier will require about 100% of its debt to be covered, but it may accept some presales that don't necessarily qualify from the senior financier's perspective;

o Presales on acceptable terms – I expand on these terms below;

o Unconditional contracts (subject only to the issue of title and, in respect of developments including houses/apartments (rather than just the sale of sections), a code compliance certificate). A financier will expect that any vendor conditions (which generally relate to the granting of all necessary consents; the availability of finance; and an acceptable level of sales being achieved) are satisfied by the developer prior to drawdown, or the financier is comfortable that they will be satisfied within a reasonable period of time;

o Presales must be entered into with either permanent NZ residents or NZ citizens, evidenced by acceptable documentation, unless otherwise agreed by the financier. From a financier's perspective there is less likelihood of an NZ citizen or resident defaulting on its obligation to settle. In my experience, at present banks are reluctant to rely on many presales entered into with

non-residents as qualifying. If they do, then they will generally require that a higher deposit (generally 20%) has been paid. In these cases, clause 11.4(1)(b)(i) of the standard ADLS agreement for sale and purchase of real estate (if used) should be deleted, as this provides that the amount of the deposit which the vendor can retain on cancellation of the agreement is limited to 10%;

o A purchaser must not be related to the developer or any guarantors;

o The proportion of multiple lot/unit purchasers must be acceptable to the financier. From a financier's perspective there is more settlement risk with a multiple purchaser. In my experience there isn't a "hard and fast rule" as to what banks will accept in respect of multiple purchasers and it will depend on the particular transaction and generally the credit position of the purchaser and the bank's comfort level as to their ability to settle on multiple purchases; and

o Any sunset dates in favour of a purchaser must generally be not less than 9 to 12 months after the expected date of practical completion. This provides the bank with comfort that if there are construction delays the developer has a reasonable period to complete the development before purchasers are entitled to cancel their contracts.

o Deposits of at least 10% for NZ Residents/Citizens and 20% for Non-NZ Residents/Citizens, held by the Borrower's solicitor as stakeholder. Also, an undertaking from the Borrower's solicitor not to release such deposits without the financier's consent, unless contractually obligated as stakeholder to do so (but not to the developer itself without consent).

3

What constitutes acceptable terms?


A financier will generally expect a report from its solicitor on the standard form of sale and purchase agreement utilised by the developer, confirming that it is an acceptable form. The financier will also require a spreadsheet setting out the material terms of the presales, including purchaser, purchase price (exclusive of GST), deposit payable and paid, settlement date, conditions, any sunset dates and any variations to the standard form of sale and purchase agreement. While a financier will sometimes accept this from the developer's lawyer, in the majority of cases it will require its own solicitor to review these details against the agreements and confirm that the schedule is accurate. A sale of a property in a development, where the property is yet to be constructed and is being sold off the plans, is obviously very different to a standard sale of an existing house or apartment. The agreement needs to provide a framework for what happens over the course of the development and take into account the various stages of the development and how various matters may affect the final product sold, and what each party's rights and obligations are in respect of such matters. David Gilbert has already presented on purchasing off-the-plan units and will have touched on some of the issues that need to be taken into account. From a financier's perspective, there are a number of provisions that they will expect to see in such agreements in order to protect the integrity of the development and to ensure that agreements are as robust as possible from a vendor's perspective to ensure that settlement risk is mitigated as well as possible. In my experience in acting for financiers, often the standard form of agreement is provided to the financier and its solicitors at such a late stage that to the extent that I or the financier have any issues with the agreement it is difficult to provide for them without seeking

purchasers to agree to amendments, which obviously isn't a popular course of action for developers or purchasers and often financiers are required to otherwise try and get comfortable with agreements that don't meet their normal requirements. I would encourage any solicitor acting for a developer to recommend that the form of agreement that is proposed to be used is provided to the developer's proposed funder as soon as possible and preferably prior to going to market, for their input and approval. This will often save a lot of time and cost for the developer when looking to confirm their financing. Financers' will generally expect agreements to include the following provisions. For the purposes of this paper I am referring to "build developments" (and not just the sale of sections):

o Interests on Title: The vendor reserving the right to grant or receive the benefit or restriction of any easements, rights, covenants, consent notices, encumbrances etc which may be required in order to satisfy any consent conditions or which in the opinion of the vendor are necessary or desirable in respect of the land or the development, with the purchaser acknowledging that it takes title to the units subject to such interests. Ideally, if the terms of any land covenants, consent notices etc are known at the time that the agreement is entered into then these should be scheduled to the agreement.

o Measurements: An acknowledgement that all measurements are approximations and subject to variation and neither party can bring a claim against the other based on any variation, nor can the purchaser requisition the title on the basis of any variation. Generally, I see this provision extended to provide that if the final measured area of the unit is greater than

3

What constitutes acceptable terms - continued


5% less than the area of the unit recorded in the agreement then the purchase price is adjusted down by the same proportionate amount as exceeds the threshold. Financiers don't have an issue with this but sometimes purchasers negotiate a cancellation right as well to the extent that the threshold is exceeded, which can cause issues from a financier's perspective.

o No caveat: The purchaser being prevented from caveating the title, until at least a separate title has issued for the purchaser's specific property. This is obviously designed to prevent issues for the developer/financier while completing subdivision documentation.

o Delays: The vendor not being responsible for delays in construction beyond its reasonable control, nor for any delays in securing consents, permits etc. The purchaser should rely on a sunset date clause to protect it from any substantial delays.

o Substitution of Materials: The vendor being entitled to substitute materials of a value and quality as near as reasonably practical with the specified materials, to the extent they are unprocurable.

o Alterations to Plans & Specifications: The purchaser not being entitled to make any objection or requisition or claim for compensation because of any alterations to the plans and specifications because of a requirement of a local authority or which become necessary or desirable in the vendor's opinion during construction, provided they don't detract materially from the value or appearance of the development.

o Signatory personally liable: That where the signatory executes with the provision for a nominee or on behalf of a company or as the trustee of a trust, that the purchaser and signatory are at all times personally liable. Financiers won't accept agreements as qualifying that are entered into by a company without signatories being

personally liable or a separate guarantee provided.

o Power of Attorney: A power of attorney from the purchaser to the vendor to execute all documents and perform all matters to complete the development, deposit plans, withdraw caveats etc.

o Stages: Where a development is to be staged, an acknowledgment that the vendor reserves the right to complete the development in stages. However, the agreement should be very clear that the vendor is under no obligation whatsoever to complete any further stages and that the purchaser is not purchasing the unit in reliance on any further stages being completed, with any marketing materials, plans and specifications attached to the agreement and references to Consents etc being very clear in this respect, especially in light of the recent Court of Appeal case relating to the Kawarau Falls Development in Queenstown, Ho Kok Sun v Peninsula Road Limited (in receivership and in liquidation) [2016] NZCA 427, where it was found that the vendors under agreements for sale and purchase of units in Stage 1 of a proposed multi-stage precinct development were obligated to complete further stages, that this obligation was an essential term of the agreements from the point of view of the purchasers and that at the time of settlement of those agreements the vendors committed an anticipatory breach of their obligation to complete the later stages and were not entitled to cancel the agreements and forfeit the deposits because they were not ready, willing and able to perform all of the terms of the agreements because they had effectively disabled themselves from ever completing the later stages.

o Deposit of subdivision plan: An acknowledgment that the vendor doesn't warrant as to when the subdivision plan will be deposited with LINZ. The Vendor is still subject to Section 225(2)(b) of the Resource Management Act 1991 (RMA) which can't be contracted out of, under

3

What constitutes acceptable terms - continued


which the purchaser can, two years after the date of granting of the resource consent or 1 year after the date of the agreement, whichever is later, rescind the contract if the vendor has not made reasonable progress towards submitting a survey plan for its approval or has not deposited the survey plan within a reasonable time after the date of its approval.

Financiers generally won't accept agreements entered into within 14 days of drawdown due to the risk of cancellation by a purchaser under Section 225(2)(a) of the RMA.

o Force majeure: That the Vendor can cancel the agreement if factors beyond the Vendor's reasonable control prevent the Vendor from commencing or continuing the construction of the Development or render it impractical or uneconomic. I have seen this clause used on several

occasions recently by developers seeking increases in purchase prices as a result of increased funding costs, with the implication that if purchasers don't agree to a price increase then the developer will cancel their contract and re-market properties at a higher price. Financiers will generally require an undertaking from the developer that it won't utilise such clause without the financier's prior written consent.

o Entire Agreement: The Agreement and schedules and attachments to the Agreement contain the entire agreement between the parties, notwithstanding any negotiations or discussions prior to execution of the Agreement and notwithstanding anything contained in any brochure, showroom, report or other document.

4

Additional representations from Purchasers


Following the GFC, a number of banks have sought for developers to include an additional suite of representations in their sale and purchase agreements from purchasers to provide additional comfort around the circumstances in which a purchaser enters into and accepts a sale contract. These were developed following a number of purchasers seeking to cancel contracts during and following the GFC, using a variety of arguments. Where a developer has yet to embark on marketing a development to potential purchasers, banks find it desirable to have these special conditions of sale incorporated into the sale agreement. The rationale is that such clauses may assist in de-fusing possible claims made by a disgruntled purchaser about the basis on which they entered into and accepted a sale agreement. Ultimately though, these matters are fact-specific and a Court may still find that a purchaser was induced by certain representations made by the vendor at the time the agreement was entered into, which may provide the purchaser with a remedy under its sale agreement against the vendor. These special conditions will not prevent a purchaser with rights against a defaulting vendor, and banks acknowledge that if they are enforcing their security as mortgagee they do not get a better claim than the vendor has. However, a mortgagee could potentially have a breach of contract claim against a purchaser. If a mortgagee sells property and gets less than the original purchase price, then it could sue the original purchaser for damages. These additional representations generally involve the purchaser representing that:

o it has obtained independent legal advice, and the vendor hasn't recommended that the purchaser use, or required the purchaser to use, a particular solicitor;

o the agreement constitutes the valid, binding and enforceable obligations of the purchaser;

o no collateral or side agreement has been entered into with the vendor, an agent, or any other relevant person;

o the vendor hasn't indicated its intention to cancel or in any way call to an end the agreement;

o in entering into the agreement the purchaser hasn't relied on any representation made by or on behalf of the vendor or its agent which is not set out in the agreement, and the agreement represents the entire agreement between the parties;

o in paying the deposit it has not received any assistance from the vendor, its agent, any selling agent or any person acting directly or indirectly on behalf of or related to the vendor;

o no payment has been made to it or agreement made to receive any fee or commission or receive any other incentive or financial assistance in order to settle;

o it has no rights of set-off with the vendor under the Agreement; and

o it is not related to, associated with or employed by the vendor or any director or shareholder of the vendor.

5

Additional representations/ undertakings from Developer


In my experience, financiers also seek additional protection in the nature of additional representations and undertakings from the developer itself in respect of the sales contracts and the developer's actions in connection with signing up the sales. These generally touch on the same matters as described above. The purpose of these is not only to give a financier the right to accelerate the loan to the extent that any covenants prove to be incorrect, but to emphasise to developers the importance placed by the financier on the sales contract. This is further achieved by the directors of the developer sometimes also providing the same undertakings personally and accordingly having person liability for their breach. Financiers may also seek an undertaking letter from the solicitor acting for the developer, given that they will generally have been heavily involved in the process of signing up purchasers, that they are not aware of

anything which could result in the developer's representations and undertakings being incorrect or misleading. This is in addition to standard undertakings regarding the holding and release of deposits. In my experience, most solicitors are reasonably happy to provide these undertakings. Where resistance has been encountered, the solicitor concerned generally doesn't believe it is aware of all of the developer's arrangements in order to provide the undertakings in an un-qualified form, the developer may have used different solicitors for various aspects of the development or the solicitors acting on the financing may not have been involved with the preparation and signing of sale agreements (sometimes the real estate agent will have had a larger role).

6

Unit Titles Act 2010 (UTA) disclosure requirements


I don't intend to go into any real detail regarding the provisions of the UTA regarding disclosure, other than to comment on financier requirements when reviewing sale and purchase agreements for units and issues that I have encountered in this respect. Section 146 of the UTA provides that pre-contact disclosure of certain prescribed information must be made before the parties enter into the contract. Accordingly, a pre-contract disclosure statement (PCDS) shouldn't just be attached to the back of a sale and purchase agreement and signed after the sale and purchase agreement. With new developments much, if not all, of the prescribed information to be made in such disclosure may not have been available when the agreements were entered into it is my firm's practice (and that of a number of other firms as I understand it) in order to comply with Section 146 of the UTA to still provide the PCDS to the purchaser prior to their entry into the sale and purchase agreement and to note in the relevant sections that the information isn't currently available and to then provide such further information as and when it becomes available in accordance with the additional disclosure provisions of the UTA. When acting for a financier, it is my expectation that the vendor's solicitor has taken the same approach. If they haven’t, I can’t give a clean sign-off to the financier. While the obligation of the seller to provide a PCDS under section 146 is an absolute one (with section 145 of the UTA providing that a provision in any agreement to exclude or limit the obligation to disclose having no effect), the UTA (in contrast with the position regarding pre-settlement disclosure statements and additional disclosure statements) provides no sanction or remedy for the seller's breach. As far as I am aware, the common view within the

legal fraternity is that it is most regrettable that Parliament didn't choose to address this issue and that, unless or until this omission is rectified, it will be left to the Courts to determine the consequences of breach, and there can be no certainty of what the results will be. It is for this reason that in my view sellers should always ensure that they provide PCDSs, even when some or all of the relevant information is not available. There is a risk that failure to give a PCDS may render the agreement illegal under the Illegal Contracts Act 1979. If so, the agreement would be of no effect. The seller would then need to apply to the Court for relief under Section 7 of the Act to validate the agreement. Alternatively, if the Courts were to find that failure to give a PCDS does not make the agreement illegal, there is a risk that a purchaser may argue that failure to give a PCDS is the breach of an implied term of the contract, for example an implied condition as to the formation of the contract, an implied condition as to the performance of the contract, an implied warranty or an implied promise as to performance of the contract, with the standard remedies for breach of contract available to the purchaser. My firm requires that the person who has made pre-contract disclosure (whether the developer itself or an agent) executes an undertaking letter in favour of my firm and the financier confirming the same and that they have complied with any additional disclosure requirements. I do not rely on copies of signed pre-contract disclosure statements as I can't determine when they were made. I also include a provision in the developer's undertaking letter whereby they undertake that they have complied with all of their disclosure requirements, they are aware of their ongoing obligations and undertake to comply with all such obligations within the applicable timeframes. Most important here is

6 Unit Titles Act 2010 (UTA) Disclosure Requirements – continued


their obligation under S 147 to provide a pre-settlement disclosure statement to the purchaser no later than the 5th working day before the settlement date. If this isn't complied with, and the purchaser elects not to postpone the settlement date, then the purchaser can cancel the contract on giving 10 days' notice to the vendor.

7 Shared funding of infrastructure for Greenfields Developments


There has been a lot of media commentary regarding the need for Auckland to increase its supply of residential housing and particularly affordable housing. Related to this, is obviously the need to build the necessary infrastructure to service that housing. It can take a significant amount of time for Council to commit to developing such infrastructure and then of course put it in place. I have seen several examples lately of where a group of landowners have joined together to undertake the development of the necessary infrastructure to service their residential developments, with the landowners sharing the cost. I have acted for two different financiers on such an arrangement in Hobsonville involving approximately ten different landowners. This can be a very complicated and expensive process for the parties involved, but necessary if they want to get their developments off the ground. Often there are cultural and language issues and it really involves at least one strong and committed personality to bring everyone together and co-ordinate the process, together with good legal counsel to put in place the necessary documentation. I can see more and more such arrangements being necessary in order to keep new developments in greenfield areas outside existing boundaries moving forward. From a financing perspective, it is important to ensure that if a developer encounters problems and defaults on either or both of their obligations to the other landowners under the shared infrastructure arrangements or their lending arrangements with the bank, then the bank is able to step into the shared

infrastructure arrangements, get the benefit of the same (and rectify any issues) and move forward to complete the infrastructure in order for the development it is funding to also be completed. In the transaction that I was involved in there were a couple of fundamental issues from a financier's perspective with the shared infrastructure arrangements. Firstly, if a landowner breached its obligations to the other landowners then its rights under the shared infrastructure arrangements could be terminated without any provision for a financier to be notified of the breach and given the right to remedy. In addition, the appointment of a receiver by a financier of a landowner would immediately result in a breach under the shared infrastructure arrangements and termination of the landowner's rights under the shared infrastructure arrangements. Given the importance of the shared infrastructure arrangements to the feasibility of the development being funded by the bank, it was essential that the bank had the ability to keep such arrangements on foot in a default scenario. Following a great deal of negotiation and time, arrangements were eventually put in place to give the bank the comfort it needed but a lot of time and stress could have been avoided if the landowners had put in place a structure from the outset that was going to be bankable. Given almost all of the landowners were going to require finance to complete their developments it would have made sense to put these measures in place originally.

8 Topical issues in property financing and 12 month horizon


There is a lot of interest at present in property development and the financing of the same, particularly in Auckland. I am not an economist and am certainly not in a position to be providing economic advice regarding the property market. The following are simply my observations from working within the industry and from discussing various issues with other people within the industry, with a particular focus on the Auckland market. There is clearly a lack of supply of residential housing in Auckland and a desire for much more development to occur. However, a combination of factors appear to be restricting the amount of new development being undertaken at present and expected to be undertaken in the near future. A major factor appears to be that banks have become more cautious in committing to funding new property developments. Factors relating to this are:

o A lack of liquidity in banks' balance sheets resulting in them putting the handbrake on new lending as they seek to increase cash on their balance sheets as deposits catch up:

• deposit rates have been so low that customers have been investing their cash in assets such as property or shares leading to a shortage of deposits. It is hard for a bank to compete with say a 7% return that a customer can earn by investing their cash in a property syndication, and property syndications have been getting bigger and bigger, and attracting more and more cash, than might otherwise have been available in bank deposits;

• in addition, following the introduction of the Reserve Bank's higher LVR requirements on investors (requiring residential investors borrowing from banks to have a deposit of at least

40%), investors need to use more of their own cash in funding purchases than the bank's money, which also takes cash out of deposits. However, conversely these higher LVR requirements appear to be resulting in decreased investment activity and may encourage increased investment by way of deposits. Auckland's biggest real estate firm Barfoot & Thompson has reported a massive slump in sales during October in further evidence that the latest round of Reserve Bank LVR measures is starting to have a significant effect on investment;

• house prices have increased and people feel like they have got more money to spend because their asset wealth has increased, they may live outside their means and again this can have a flow-on effect of less cash being put on deposit; and

• property lending has been growing at such a fast rate that to continue to grow at that rate would require the banks to bring in a lot more funding, either from deposits or from wholesale borrowing. If that additional funding is coming from overseas then there is a lot more risk for the banks and they do not want to be too reliant on off-shore funding, as they were during the GFC.

o With commercial property lending, banks need to hold more capital on their balance sheet as it is seen as a riskier asset class. The banks have a limited pool of cash to lend to this asset class and are waiting for existing commercial property loans to be repaid in order to recycle that money, rather than lending increased amounts. For the amount of capital that needs to be allocated to commercial property lending, it may be better for the bank to allocate that capital to a different asset class,

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Topical issues in property financing and 12 month horizon – continued


where it can receive a better return on its capital.

o The Banks appear to be particularly more cautious regarding the funding of multi-unit developments. The four largest banks in New Zealand are all owned by Australian banks. There is a current perception that there may be an over-supply of apartments in the Australian market and there have been some recent issues with non-resident purchasers in Australia failing to settle on apartment sales. The fears regarding the Australian market may be having an effect on the financing of this asset class in New Zealand, notwithstanding the fact that we don't currently have an issue with over-supply and we haven't as yet had issues with non-resident purchasers failing to settle.

o Related to the above, in my experience banks are more comfortable funding "owner occupier" apartments/terraced housing in higher value, city-fringe locations than central city apartments which are generally purchased by investors. Following the GFC, the former asset class held its value better than the latter. These city-fringe developments are also less risky to fund than suburban developments given both types of developments have similar costs of construction, but the city-fringe, higher value developments should be able to command a better profit for the developer (notwithstanding the need to include higher spec fit-outs, appliances etc).

o Building costs are increasing. Because of the number of developments that are being undertaken at present, and the large infrastructure projects being undertaken (or soon to be undertaken), construction companies, and particularly sub-contractors, are very busy and there is a lack of supply of labour, leading to an increase in labour costs. The GFC resulted in a number of people leaving the construction industry, moving overseas etc and this has contributed to the lack of

current supply as it takes time to re-train people. Concrete is expensive and there is a shortage of people to put it in. Material costs are increasing because of high demand.

o Related to the above, construction programmes and timetables are being pushed out. There is huge demand on earthmoving at present (just look at all the road works being undertaken) which can contribute to pressures on construction timetables. If developers miss their slot for getting their concrete laid then this can result in delays of weeks as they wait for another slot. These delays result in increased costs. They also result in delays in repayment and the ability for the banks to re-circulate that money in funding new projects.

o Related to the above, cost overruns are occurring on developments. Banks generally require the developer to be making a 25% profit on a development. If the Banks are concerned with the potential for cost overruns to occur, then without a sufficient margin in place this constitutes a more risky funding proposal.

o A large development will generally have an 18 to 24 month cycle to completion. With the prospect for potential cost overruns and uncertainty as to whether house prices may drop over such a period (the bank is relying on presales entered into at today's prices and if prices drop in the market then settlement risk increases) the funding of developments is more risky. We have seen examples in the media recently of proposed developments falling over because developers can't get committed funding for these reasons. Also, with a focus by the government (driven heavily in the media) on making housing more affordable, then to achieve this you would expect that prices need to decrease. If cheaper housing comes on the market at the same time that bank funded development is settling then this increases settlement risk. There is

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obviously a potential issue for banks looking to fund in a market where they know a number of parties are trying to correct it.

o There are delays in the consenting process for developments as developers/Council wait for the Unitary Plan to be implemented/appeals heard.

Looking forward over the next 12 months or so, we may see the following occur:

o A sustained period of cautious lending by the banks for the same reasons as detailed above.

o An increase in funding costs for developers. Bank liquidity premiums are going up because it is more expensive for the banks to source overseas funding and these increased costs will be passed on to borrowers. Globally, an increase in interest rates is expected.

o A desire by banks to focus on looking after their existing customers that have good track records and the banks are confident have the expertise, resources and capability to complete developments, rather than focussing on new business. With less competition amongst the banks , developers will have less options and will inevitably be required to incur higher funding costs in order to get committed funding. From what I have seen, borrowers are accepting this and access to capital is more important to them than the pricing.

o A continued focus by banks on deposits. Interestingly, ANZ has recently announced an 8% growth in deposits. However, it is clear that deposits still trail growth in lending.

o New players entering the market to provide property development funding:

• there are transactions that would normally be funded by the banks but for different reasons (many of which

are articulated above) are not at present, resulting in an opportunity for new players to enter the market, but if they were to flood the market like we had with finance companies leading up to the GFC there could be some issues going forward;

• we have already seen three large Chinese banks enter the New Zealand market over the last couple of years with these banks also receiving increased capital injections from their parents. They will become busier and busier if the Australian banks continue to take a more cautious approach;

• we have also seen a number of smaller finance companies enter the market which are generally funded by private capital, and in some instances additional bank funding lines. We would expect to see more of these entities enter the market. The debt is more expensive for developers and generally takes longer to arrange but if they can't source funding from the banks then they will need to pay more to get developments completed;

• overseas lenders, hedge funds etc have been sniffing around the market and may commit. However, generally an overseas hedge fund requires a deal of at least $40 - $50m to make it feasible for them; and

• we may see institutional grade developers from Australia enter the market - entities that are large, publically listed and with strong balance sheets which can overcome funding issues in the market. These would be entities similar to Fletchers, who are undertaking a large amount of residential development in the NZ market at present.

o If apartment projects currently being undertaken in Australia complete and there are aren't any significant issues with purchasers failing to settle and bank debt

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is repaid then this may provide more confidence for the banks in funding developments going forward in New Zealand.

o Land prices may adjust at some point. If banks have provided funding to enable developers to purchase land and "land bank" it and those developers are unable to refinance/fund the development on the land, then they may be forced to sell which could result in land prices reducing.

o A much less talked about issue which has the ability to constrain land development that may become more relevant is the capacity of existing infrastructure to cope with, or accommodate, higher density.

o The Reserve Bank has formally asked the Government for a tool restricting debt-to-income ratios on residential mortgages to be added to its macro-prudential toolkit. Just as the higher LVR requirements on investors appear to be having an effect on slowing investment in that area, these debt-to-income restrictions could also slow demand in residential mortgages but it remains to be seen what sort of requirements may or may not be imposed and the effect of the same.

o It is an election year next year. House prices and immigration are two very important issues at present. Depending on who is in power following the election, their policies could have a dramatic effect on the property market and the funding of the same. For example, the introduction of a land tax on foreign owners or a drop in immigration allowances could have a big effect on property prices.

It will be interesting to see how things play out over the next year.

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Documents

Property Finance Update · Contents © Simpson Grierson 2016 Section Page Introduction.....1 Structuring of a standard property development financing transaction