PROJECT FINANCE
What You Need To Know
If you are about to undertake a property development, it may pay to explore your project finance options well in advance. Project finance is not a one-size-fits-all proposal, each project has a number of parameters unique to it and that will determine how best to finance towards a profitable and problem-free completion.
A horses-for-courses approach involves detailed analysis that will reveal a financing option that is best-fit-for-purpose as different lenders have different risk appetites, preferences, and requirements.
In recent years, the credit market has experienced a proliferation of pop-up businesses positioning themselves as “lenders” in their own right but are nothing more than a conduit for unsophisticated investors seeking higher returns for higher risk, as has happened in previous cycles.
This starts to make sense as we look at the essence of banking and finance, it’s all about the management of the relationship of risk to reward, ie; the basics of finance is the risk:reward ratio where risk must be fully assessed and adequately priced – something that is drummed into every Banking & Finance student at university.
How Does Project Finance Work?
LINK Commercial Mortgages is engaged typically at Early Stage, even before a project site is acquired. This allows us to work with our property developer clients throughout the lengthy process of Planning, DA submission, Project Documentation, and procurement.
If you already have an approved project, we are capable of jumping in at that stage, however, it is wise to keep in mind that Project Finance is not the last piece of the jigsaw puzzle; rather, it should be one of the Property Developer’s foremost considerations as often leaving it to the last minute means that overlooked aspects will likely adversely affect the quality and efficiency of Project Finance.
In the case where a raw site is being acquired, with a lengthy process ahead to obtain development consents and construction documentation, land-banking finance arrangements that may have been hastily put into place could well eat away at ultimate project profits and erode the sponsor’s equity in the property and ultimately the project.
For this and other significant reasons, it pays to get us involved as early as possible in the life of a property development project.
LINK Commercial Mortgages is a boutique commercial mortgage originator and Finance Consultancy that has been engaged by property investors and developers since the late 1990s to fund their residential, commercial, industrial, and mixed-use property investments and developments.
Over the past 25 years, LINK Commercial Mortgages has worked closely with its property developer clients to structure finance solutions that are best-fit-for-purpose and optimally priced to avoid the unnecessary erosion of equity and project profit.
We are engaged to provide forward-thinking Project Finance arrangements that include end-purchaser finance for pre-purchasers, residual stock refinance, as well as investment finance to allow the long-term holding of commercial components of mixed-use projects by developers - all forward planned and arranged.
Other achievements arranged for our property developer clients include full, 100% project funding using hybrid structures of senior debt, mezzanine finance, and in some cases preferential equity as well as the recognition of equity from the added uplift in land value.
More and more common is the requirement for zero pre-sales as our developer clients strive to build-and-retain their projects for investment and wealth augmentation purposes. Delaying sale during an upward market may enhancing sales returns, while also exploiting the benefits of Tax Depreciation that aim to increase net rental return.
Of course, all of this will depend on the inherent aspects of your project, how we identify and manage those items, and on the strength of our negotiating position with institutional investor clients, with whom we have enjoyed a long-running continuous relationship based on consistent levels of business over the years.
Understanding who are the key stakeholders, part of LINK’s scope of services includes conducting market research to build a profile of your project. Armed with this, LINK enters into a pre-engagement tendering process with select valuers and quantity surveyors with the view to establishing certainty of numbers. LINK conducts an on-going workshop of the analysis of your project with a selected institutional investor to avoid surprises with the funding outcome and setting a clear strategy to address potential funding shortfalls, if any.
Are you familiar with the requirements of the Strata Building (Defects) Bond & Inspections Scheme and how to navigate these? We are, and this is included in our scope of services.
To emphasise the value of our relationships with our institutional clients: in a recent matter, we arranged project finance on very favourable terms from our client’s own bank which had rejected their application several months earlier.
The Bottom Line
The financing of Property Development is a complex matter that must be executed fully and correctly and from the outset in order to optimise the net profit yield of a project, especially where there is a lengthy project timeline.
It’s not always about the interest rate… commonly the first question by an unsophisticated property developer. Other restrictive terms and security structures can and do adversely affect the smooth progress of a project, especially during the construction phase, which may all contribute to the erosion of equity and project profit.
Some property developers may not fully appreciate the value in engaging and paying for the services of a highly qualified Professional Finance Consultant; consider the following illustrative example of competing finance offers:
It is a common error to add an interest rate charged on funds drawn-down to a line fee charged on the face value of a facility and believe the sum to be the actual cost of debt:
3.0% pa interest rate + 4.0% line fee = 7.00% pa
…and then compare it to
6.5% pa interest rate + 1.75% line fee = 8.25% pa.
It is a common error to believe that the former is “cheaper” (ie; more favourably priced) than the latter, where in fact it is the exact opposite, a fact that is discernible with simple discounted cash flow modelling.
Couple that with the front-end and back-end finance terms and there is a staggering difference, a significant and unnecessary “leakage” of project profit.
Once again, it’s not always about the pricing; banks are notorious for over-securing their debt exposures, ie; taking mortgage security over more of your properties than is required.
So, remembering the risk:reward ratio, consider the disproportionality of the following two project finance pricing scenarios:
4.55% pa for a fully funded project against the security of the project site only
VS3.55% pa fully funded project against the security of the project site + your otherwise unencumbered family home + your factory + your investment unit.
Which would you prefer, the less expensive one? What about if your project ran into cost over-runs and required you to inject more equity, where would you get it? With unencumbered or lowly geared property, one could increase the mortgage or refinance & top-up, or even contribute that property to the project financing bank for an increase in project finance.
If the bank has tied your hands behind your back, your only option could be to break the restrictive covenant (the Negative Pledge) by arranging a significantly over-priced second mortgage and risk being put under default arrangements with the bank.
With The Real Property Amendment (Certificates of Title) Act 2021 coming into effect 11 October 2021, it is no longer a requirement to obtain the bank’s consent to increase borrowings on the security of a second mortgage over the property held by the bank; however, the Negative Pledge that you have contractually agreed to is there to prevent you from borrowing more money to meet, for example, increased construction costs.
LINK Commercial Mortgages has been in the industry assisting professional property investors and property developers to finance their property investments and projects for 25 years. We know all the tricks of the trade and once you engage us, we are working for YOU.