[+] Funding Faces a Shake-Up as Pipelines Back Up

A shift in the costs of bank versus non-bank lending will shake up where the property development industry sources its financing this year. The market is awash with new entrants, and major funds are looking at more fixed-return style of investments after a year of sustained investor interest. This interest came from both offshore and domestically, says Bill McWilliams, head of the national investment team at MaxCap Group. “In a world of elevated interest rates, the case for investing in real estate credit became more compelling and it compares well with other global strategies across risk and return, with good structural resilience,” he says. But while the investor interest is there, feasibilities and pipelines are causing issues from a developer side of things, according to Dan Holden, the founding partner of Holden Capital Partners (HCP). “In terms of developer demand, it remained firm, however the quality and viability [of projects] was substantially less than in past years, which meant a significant increase in the amount of due diligence is required relative to the number of settled transactions.” Banks and non-bank lenders What may change in the coming year is the balance of bank and non-bank lenders, according to Bill McWilliams at MaxCap. “The non-bank space will always provide a level of flexibility to developers to launch the projects required in tougher markets, the banks will come into market and retreat whereas the non-bank space is consistent in terms of backing,” he says. Some major structural changes have happened in the lender space as a result of heightened risk and interest rate rises. “Non-bank finance was typically around the 10-12 per cent [all up cost inclusive of establishment and line fees] rate pre-interest rate rises,” says Dale Sparke at Stac Capital. ▲ Mark Trayner and Dale Sparke of Stac Capital, which structures and sources debt and equity for developers. “Banks bounce their funding off BBSY [Bank Bill Swap Bid Rate, a rate used by financial institutions and investors to determine short-term floating interest rate], which means the gap between bank and non-bank finance was considerable, it would effectively be double. “Now we’re seeing that the gap in the finance market between bank and non-bank has narrowed and some non-banks have had to change how they price [capital]. “It makes it almost compelling to go down the non-bank finance path, if you’re looking at a significantly lower presale hurdle and a lot more leverage,” he says. As a result, a lot of business has been funnelled into the non-bank market, which has forced risk appetites to change, says Stac’s Mark Trayner. “If you’re looking at residential development, banks have pulled back on the presale coverage metric. Banks were typically going for 80 to 100 per cent debt cover six to twelve months ago. Now we’re seeing them in 60 to 80 per cent debt cover,” Trayner says. ▲ Bill McWilliams of MaxCap in Australia, which has recently collaborated to fund major projects, including Quintessential’s Adelaide office refurbishment. On the other side of the coin, non-bank funders who were operating at anywhere from a zero to 25 debt coverage are now sitting at 25 to 50 for large scale deals, he says. “Appetite has definitely come back [from banks] and there is obviously a strong demand and shortage of stock coming on to market because of all these projects that have been stuck with the rise in construction prices or, more importantly, they have not been able to find a builder that is aligned with the finance.” The administration of St Hilliers this week was evidence that the volatility of the construction sector persists. Construction costs and opportunities It is no secret that the construction sector has struggled but what developers were perhaps not prepared for was the extent to which this volatility would impact how projects were financed. While material prices might be on the way to stabilisation, labour costs are still proving to be a major issue. “The cost escalations in construction isn’t unique to Australia of course,” Bill McWilliams of MaxCap says. “As a result, the level of due diligence on builders has stepped up significantly,” he says ▲ According to EY, lowering the tax rate to 10 per cent for build-to-rent projects with affordable components could fast-track 10,000 new affordable homes. Mark Trayner and Dale Sparke of Stac Capital agree, saying that the focus on construction has led to lenders being more amenable to different risk structures. “A few years ago, lenders didn’t like builder-developers but it’s swung the other way. “Now they prefer it and see the benefit in it, they can see the builder’s pipeline, its strengths, and know they have a vested interest in delivering on budget versus a third party,” Trayner says. The former crutch of fixed-price contracts can no longer be relied upon, Sparke says. “They just don’t feel comfortable with that level of risk, so that’s why we will see and hear a lot of chat in terms of JVs with developers and builders.” ▲ Dan McLennan, founder of Melbourne-based build-to-rent developer Local Residential, which is working on projects at Box Hill, South Melbourne and Kensington. But one sector in residential that has experienced sustained interest is build-to-rent, compounded by beneficial government changes that lower foreign investment fees for build-to-rent projects. “We’re certainly from a local perspective seeing appetite predominantly from offshore pensions and pension funds and institutional investors,” Dan McLennan, founder of Melbourne build-to-rent developer Local Residential says. “We’ve seen a lot of interest from Asian investors, but investors for the most part who have experience in build-to-rent in the US and UK, so they are comfortable with the product and the opportunity that we deliver that is the growth story of Australia.” Of course it’s not only build-to-rent that is proving resilient in attracting capital of all types, says Dan Holden. ▲ Dan Holden founded Holden Capital Partners in 2015. “From an investor point of view we had a large increase in the amount of industrial projects HCP funded in 2023,” Holden says. “We see it as a good balance of portfolio for some investors of ours who might currently be investing in high-end luxury residential which has seen significant time delays in their delivery, compared to a simple quick set of 10 sheds, which go up in under five months.” The future of funding While there are potentially real estate assets that are considered a more solid investment decision, there are no guarantees in funding. “Bank’ appetite is constantly changing, whilst private appetites and availability can have a huge variance based simply off which private funder you are talking to and if that particular project aligns with their investment mandate,” Dale Sparke at Stac says. “Liquidity issues have also arisen due to investors taking a more risk-adjusted approach to the current market conditions. “But we’re optimistic as far as the general market is concerned, although there are certainly going to be challenges and this will continue. Property values won’t tumble, they will hold up, but getting feasibilities to stack is a continuing challenge.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

[+] Funding Faces a Shake-Up as Pipelines Back Up

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