Securing funding for a project is a key talent for developers.
Good developers would have an eye for site selection, are adept at managing consultants and disciplined in project management. Add onto the tool belt a flare for sales, marketing and managing settlements in an uncertain market.
While these are all still essential attributes, any truly successful developer also needs to understand the full spectrum of finance options.
But raising money is a subtle and complex art, and the further into the maze you get, the more questions are raised.
How much of your own money do you commit? What returns are equity participants expecting? How do you best raise money to form a syndicate? Is there a role for formalising a loan arrangement from a builder?
Which is better: a senior loan with a modest loan-to-value ratio topped up with a separate mezzanine finance facility, or a “stretch first” loan where a single lender effectively provides both using a higher loan-to-value facility?
There will be a deed of priority and subordination between a first mortgage lender and a mezzanine financier – do you understand what key aspects to look out for in that agreement that may affect you as the developer?
As an added complexity in recent years, tougher rules from more vigilant regulators have put the squeeze on banks, forcing them to pull back from funding developers.
Into this vacuum have come a wide range of alternative non-bank lenders.
Previously, a developer could have been well-served by relying on a finance broker to prepare a pack for circulation to a short-list of traditional banks.
Rates, loan-to-value ratios and covenants were broadly similar and once the best deal was set, a formal offer was usually forthcoming. This process now has evolved. A bank may express an interest in providing a facility, but due diligence can end up being a big drain on a developer’s valuable time and the bank terms can be so onerous that it makes little sense to proceed.
Non-banks provide a new route for funding. Non-bank lenders come from different backgrounds, but those with more of a family office heritage seldom rely on sourcing transactions from broker channels as they prefer to forge a direct relationship with developers.
Less experienced developers focus on the normal three criteria to assess lenders: How much will you lend me? What interest rate will you charge? What conditions do I need to meet prior to drawing down?
A sophisticated developer understands that there is a fourth measure in any lending arrangement, which is perhaps more important than anything else. Time.
Turning to a non-bank lender could get you a far more tailored funding solution than a major bank, but the absence of a broker means you do the legwork to engage them. It’s a daunting concept that certainly takes time, but it takes a lot less of it than navigating the obstacle course of constraints offered by a traditional lender.
Time can be compressed by engaging with experienced property finance professionals who can work in an agile manner and can be unhampered by the constraints of a traditional lender. Working with the right non-bank lender regularly shaves months off the timetable to project completion.
An early start may be essential in having a project complete prior to a change in market conditions, which allows residual stock to be sold undiscounted. With a shorter timetable in any multi-year period a developer will complete more developments.
Shorter project timetables boost the internal rate of return that equity investors are so obsessed by. Say a project with $10 million of invested equity is forecast to return a $8.25 million profit over a 28-month timeframe. An equity investor will get a 29.5 per cent per annum internal rate of return. By bringing the project in by just four months, the same profit now generates a 35.1 per cent per annum internal rate of return to equity investors.
It’s no longer an option for developers to leave a deep understanding of raising money for their projects to their brokers and hope for the best. Principal and senior executives in property development need to build on their skills of understanding and assessing optimal finance structures to fund property development.
Tim Moore is a director of Dorado Property — a family office-backed non-bank lender. Moore is a chartered accountant and has had a 35 year career in finance, capital markets and investing.
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