Choosing the Right Finance Model Fit for Your Next Development

Choosing the Right Finance Model Fit for Your Next Development

Securing finance is a complex yet crucial responsibility of property developers and investors. Knowing what lenders look for in development proposals can carry a project through its preliminary funding stages and onto bigger and better milestones, but it’s important that developers choose the right finance model that suits their specific project needs.

As Australia’s banking environment continues to create an unstable – but slowly improving – lending environment, developers should be taking sound projects with strong market fundamentals to more diverse and reliable sources of finance.

Non-bank finance options can bring a project to market sooner, lower the required amount of pre-sales and keep cash free to drive the rest of a project’s pipeline. As one of Australia’s most innovative alternative funding companies, DFP makes the most of alternative finance opportunities and helps developers look beyond funding to deliver the most profitable outcome.

The expert team at DFP have put together a quick overview of non-bank finance options, to show developers their options when choosing the right finance model for upcoming projects.

 

Mezzanine Finance

Put simply, mezzanine finance is a bridge between standard bank or ‘senior’ debt, and equity investment. Mezzanine funders often have less onerous lending criteria that make the loan qualification process less complex. A well-planned mezzanine facility achieves an increased return for the developer and helps them to preserve equity.

Mezzanine debt is used to fund a share of the development costs – often the land component – which leaves the senior mortgage lender to secure the remaining debt via a construction loan.

Come the pre-sales settlement date, and proceeds from off-the-plan sales are used to pay down the construction loan and then the mezzanine debt. This debt typically has the interest capitalised to the loan amount for the project’s duration, which means loan serviceability is not required during construction.

For developers who want to use their equity elsewhere or want to avoid having a joint-venture partner, mezzanine finance could be a smart option.

 

Private Lending/Mortgages

A private lender is known to act faster than a bank or institutional lender and is typically less stringent. Private lending essentially involves one investor providing capital to one borrower. The private lender will look at underlying security property and the exit strategy.

Private lending involves no set lending requirements and allows for lenders and borrowers to agree on their own pricing and loan conditions. A non-bank lender can lend up to 65% of a security property’s completed value, without requiring pre-sales. Loan terms are an average 12 months.

Private lending comes with a price: higher interest rates and establishment fees than standard bank funding. But for developers with equity in their property who cannot go to traditional bank lenders, it’s an option worth considering.

 

Stretch Senior/Unitranche debt

A stretch senior loan can do the work of a senior loan, which is up to 65% of an on-completion valuation, and a mezzanine loan that covers from 65 to 75% of the on-completion valuation. Using a stretch senior loan means that developers can borrow at much higher leverage with a single loan, instead of using two or more sources to secure funding.

A single loan facility means just one approval process, one documentation process and only one lender relationship that a developer has to manage their lending conditions with. A stretch senior loan qualification process is also often less complex than the process with senior debt providers.

Developers with projects that are forecast to achieve above-average profitability can tolerate the higher interest cost and should evaluate their options with a stretch senior loan.

 

Preferred Equity and Joint Venture Finance

This type of loan structure has a lot of pros: no lock-ins, shared risk and rewards, and it is typically more bank-friendly.

Preferred equity is often compared to mezzanine finance but the difference is that this finance option is not secured by a second mortgage over the property. The capital partner provides capital in return for equity, which means the investor will typically receive a fixed percentage of the profit when the project is successfully completed, and an interest payment or ‘coupon’ on their invested funds.

The downside to this finance option is that the potential for conflict is increased as parties may have different decision-making strategies or management styles.

Developers who are short on equity or have profitable projects that can’t quite sustain other funding models should look to preferred equity as the finance option for their next development.

Before embarking on your next project, put in the due diligence and have the basic elements of a finance application sorted. Non-bank lenders make their funding decisions based on the features of a property’s broader context.

 

To find out the next steps on how you can reduce your risk and increase return on equity, download the TUD X DFP Get Funding White Paper or get in contact here.

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