Almost every building developer will need to consider external sources of finance when planning a new project. Bank loans, or loans from the government, are integral to the cash flow of these companies and, consequently, it is worth taking the time to consider what the payback period of these loans may mean for the overall business plan.
Recent trends suggest that payback periods for loans have been increasing for housing developers; where once an organisation may have repaid loans over 30 years, many are now looking to repay over 60 years. Although these are forecasts, and therefore companies may successfully repay the loan by year 40, for example, the significance of these longer payback periods should be considered by developers. For example, how many years will the project take to complete? Is it reasonable to expect the property to still exist in 60 years? How will the accumulation of loans affect the future risk appetite of the company?
It is generally considered good practice for companies to meet the lowest possible payback period in order to generate profit on developments. This allows the company to recover from previous building projects and recoup profits before embarking on new developments. In addition to this, by reducing the amount of interest being incurred by the business, greater future investments can be made increasing the number of houses available for purchasers. Faster payback periods may also allow a company to invest more competitively on land, and may enable social sector developers to expand beyond Section 106 deals.
Longer payback periods can have their benefits, however. By extending the payback period for a loan, companies may be able to borrow large sums of money from the respective lenders. This additional capital enables developers to extend the number of properties being developed on a project. By taking this risk and developing more properties the business is able to positively affect local communities by providing more housing and increase its potential for future profit. Another way to consider the benefits of forecasting a longer payback period is that it is better to forecast 60 years and repay within 40, than forecast 35 years and miss this deadline. The longer payback period can offer businesses more financial flexibility, which may in turn allow them to repay loans within a faster time period.
Within ProVal the maximum payback period for a loan is set at 100 years, and the costs and returns of a project can be forecast within this timeframe. ProVal allows developers to forecast different payback periods to see how these repayments may affect the NPV of a project and the IRR. This flexibility allows developers and boards to orchestrate the best development strategies for their future business plans.
Speak to our consultants today to find out more about cashflow forecasting within ProVal, and gain industry insight into the best practice for setting payback periods on loans.