[+] Safe Harbour: Lenders Back JV Deals in Construction Chaos

The construction sector continues to be rocked by the collapse of major and minor players alike, creating an atmosphere of caution among developers and funders. But a refocus on joint ventures for new developments is highlighting the more transparent way developers and builders are willing to approach doing business together. Managing director of project management and construction firm 5Point Projects Damian Dove has undertaken a host of JV projects in his 30-year career. “It is in these difficult times that you need to be able to adapt to market conditions,” he says. “We are certainly going to see a change in the way projects are delivered and relationships formed rather than the tender-style arrangement. “This was how our business has operated since its inception and it’s paying dividends for 5Point now, because this is what the market is looking for, this adaptive contracting model.” ▲ 5Point’s project with Sherpa Property Group Perspective 488 recently secured a major Master Builders award win. Clearly it is working out well for 5Point, which recently celebrated wins at the Master Builders’ Housing &amp; Construction Awards for a Highgate Hill residential development, as well as its Perspective 488 Palm Beach project with Sherpa Property Group. Funders have undergone a 180-degree turnaround in how they approach alternative project models, says Dove. “Previously it was seen as better to have that transactional separation,” he says. “Developers could take on a lot more risk and banks were protected, whereas now those banks are looking for the comfort of shared risk, where the builder has greater opportunities and likelihood of completing development without insolvency hanging over their head.” Funder perspective MaxCap head of direct investment Simon Hulett said that while it was not a new concept, JVs could help support builders in a challenging period. The non-bank lender has struck deals with developers across the country on projects, including Milieu (pictured in the main image). “It’s not unusual for builders to be invested in the projects they are delivering, but that can take different forms and it continues to evolve, and every builder and developer is different,” Hulett says. “At the smaller end of the scale it might be something that’s a bit more prevalent, where builders are working to quite small margins so in order to derive an enhanced return they are willing to do those deals.” Executive director and chief investment officer at Pallas Capital Dan Gallen says that the CRE debt and equity investment manager has built its own funding model to cater for the nuances of joint venture arrangements. “Even then, there is no rule book for how the profits and income of these projects is apportioned between the partners, so any model needs to be adaptable,” Gallen says. “This means that many ‘off the shelf’ models can be a bit clunky for modelling out joint ventures and non-standard profit-sharing arrangements.” While serious due diligence is always undertaken, there are certain elements of a JV that might come under greater scrutiny. “In terms of sponsor due diligence for JV funding, we require a thorough understanding of how the relationship between the parties will operate and any delineation of project deliverables and any profit and cost sharing provisions,” says Gallen. “It also helps if the parties have worked together previously as this demonstrates their ability to work together through the ups and downs of a development.” ▲ A render of 5Point’s Perspective 488 Palm Beach project it undertook with Sherpa Property Group. MaxCap’s Hulett agrees. “It’s definitely a case-by-case proposition, which comes down to the relationships you have in place,” he says. “If that’s a path you want to go down, you want to be confident in the alignment with their values and business, their ownership and senior leadership. “Developments always experience challenges and when you experience those challenges you need to be aligned and work in a collaborative manner to deliver the best outcome, which is what we’re focused on, on a risk-adjusted basis.” Construction sector blues It’s no secret that times are tough in construction, with the final collapse of GCB Construction last week , or soaring construction costs forcing a $450-million Brisbane project to be abandoned . Dove explains that given the issues with construction costs, exacerbated by workforce drains and fixed-price contracts, builders are also looking for other options. “Costs are facing ongoing escalation each month and each quarter, so it’s difficult to expect a building contractor to take on risk with a set margin of contingency thinking that will be sufficient over 12 months to three years or more.” It’s how you will manage that escalation, Dove says, something that the industry as a whole is working on, and can be done effectively in partnership with a developer on a more equitable playing field. This more communicative and transparent approach is being considered in different ways by developers with efforts towards transparency and flexibility , especially when it comes to fixed price contracts . ▲ GCB Constructions is the latest casualty of the construction sector turmoil, calling in insolvency specialists last week. While the JV model may not overtake more typical capital structures, it does have its benefits for a struggling sector. “It might create too much uncertainty for industry and buyers at mass scale, but certainly it will give an opportunity to projects that may not ordinarily go forward, that would be too much risk alone versus reward. In a JV arrangement, you’re both going to take some risk and reward together," says Dove. Hulett says funders have been keeping a watchful eye on the sector. “Three core elements that go into any feasibility are of course time, cost and revenue, those are the key things we really focus on,” he says. “They have all been impacted in different ways, so how do you find the right opportunities to extract value out of certain segments of the market? “There’s no silver bullet at the moment, and everyone is looking at the traditional funding models and challenging those models. ▲ MaxCap's Simon Hulett, 5point's Damian Dove and Pallas Capital's Dan Gallen think alternative development models could be a major opportunity. “When you think about a traditional capital stack, with senior debt, junior debt, preferred equity and all those different machinations, there’s some creativity that can be applied to attract capital into projects to activate them, and a lot of that comes down to track record, capability, and the less tangible things in terms of relationships and trust.” Pitfalls of a JV Pallas Capital’s Dan Gallen says the potential opportunity of JV models lies in the different skillsets, which can be brought together. “[That gives the development] potential to provide great synergies and generate much better outcomes than if the partners were to develop in isolation,” he says. “However, there is the human factor in these relationships. They don’t always work out and there is the risk of a JV dispute during delivery disrupting the project—that’s why looking at projects where the partners that are on their second, third or fourth development provides a lot of comfort that the two partners can work together over that 18 to 24 month period to deliver a project. “Having a very clear and agreed process at the start of the project that dictates what happens in the event of a dispute is important, which may result in one partner buying the other out, for example.” ▲ Joint ventures appear to lend themselves well to smaller boutique developments such as 5Point and Sherpa's Perspective 488. Ensuring a trusting partnership is key to a risk-sharing model such as a JV, says Dove. “There’s a term in industry that’s relationship contracting and that relationship contracting in a JV is going to require more transparency at both ends. “What I mean by that is that the developer needs to be able to trust the builder that they can share a feasibility with them around what is going to make the development stack, and a builder needs to be transparent back with what are the actual costs. “Basically, if you’re going to share risk, you can’t keep your powder dry.” Future projects Ensuring stable projects in asset classes with a proven track record or great potential is of fundamental importance, Gallen says. “We are being cautious, but our funding strategy hasn’t really changed – we aim to back quality projects and developers to deliver product that is in demand. “With a clear undersupply of residential accommodation for both renters and owner occupiers, we are focusing our attention on these areas, though we are still seeing boutique mixed use projects in city fringe locations perform well with tenant demand sound and considerably outperforming the CBD commercial markets.” MaxCap expects the construction sector to remain a difficult environment for some months yet. “In general, the combination of building cost escalation, higher funding costs and a patchy off-the-plan market is contributing to many projects being unviable and will continue to limit the supply of new buildings,” says Gallen. “Until one of those feasibility inputs changes (end value or cost), I don’t see a pick-up in new construction starts.” ▲ According to the National Housing Finance and Investment Corporation, 28,000 homes were delayed in 2022 due to pressure on the construction industry. However, it’s not all doom and gloom, with Pallas Capital projecting a potential steadying in the wider market. “In the market moving forward, we will see some stabilisation, and we’re already seeing that across forward yield curves and construction pricing, we’re seeing stabilisation and repricing of trading assets and I think that’s exciting. “[For us] it’s not about focusing on new sectors, it's about saying how do we really dig deep into sectors that have strong underlying fundamentals, which is the living and logistics sectors at the minute. “It’s definitely not a case of just continuing to do what we’ve done and hope for the best. “It’s about how do we find new opportunities with the right developer and investors and have absolute confidence in any opportunity we’re looking to support. “But we have to continue to improve and challenge the way we’ve done things in the past and be creative and innovative about how we do things in the future.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. 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[+] Safe Harbour: Lenders Back JV Deals in Construction Chaos

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