Current Funding Trends for Property Development
|By Development Finance Partners / Matthew Royal|
Funding Trends – Historical Background
The diversification of funding sources in the private sector to support property development is continuing. Looking at today’s trends, it is worthwhile to review the changes that have occurred in the last 30 years, to provide an understanding of the fundamental shifts during this period. Such will help explain the dynamics of the current market place.
Prior to the 1989/90 Property Crash, the Banking sector through their respective Finance Company Subsidiaries, was deeply committed to the sector, not only via solid Senior Debt plays, but also through large Joint Venture and Mezzanine exposures to developments. The sudden and severe property crash in 1989 led to a wholesale exit by these Finance Companies, many of who did not survive the shock given their exposure to equity risk.
Indeed, the level of exposure that Westpac had through its three Finance Company subsidiaries – Partnership Pacific, Bill Acceptance Corporation and AGC, led to that Bank requiring radical surgery to maintain the confidence of the market. Exacerbating the withdrawal by these institutions was the withdrawal of most of the International Banks, which entered in 1983 as a result of Paul Keating’s initiative to award 16 Banking Licences to a suite of Global Institutions in order to open up competition in the Australian Banking scene. Names such as NatWest, Chase, Citibank, and a number of Japanese Banks were active in the top end of the development finance market until 1989.
Following the 1989 crash, there was a shortage of both funding and demand for property development. It was also a period of significantly high interest rates, and a period where fixed rates of circa 12%-15% were seen as “cheap “ compared to floating rates, which at one point peaked at 17%.
Gradually, demand did return in the late 90’s and the conservative policies of the Banks saw the rise of private funding Groups, many of whom solicited funding from the retail market through the issuance of Prospectus’, offering returns well above deposit rates at the time. Such Groups flourished through the early 2000’s despite some notable collapses due to poor and often very questionable management from an ethical perspective.
As in 1989, the GFC of 2008 saw the collapse and withdrawal of most of these Property Finance Groups, and the development market again went through a lean period due both to demand, and lack of financial capacity.
With a subdued recovery underway from mid 2011, driven in part by:
- a shortage of housing particularly in Sydney;
- low and relatively stable interest rate environment, funding options from private sources are again on the rise, however in a different form.
Current Private Market Structure.
The current market in the private money space is being driven by three significant factors.
- Increasing restrictions on Bank funding to the sector due to international capital protocols (Basel 111), which demand higher capital allocation for development exposure, and therefore reducing the portfolio allocation Banks are prepared to provide into the industry.
- The ready availability/supply of both private and domestic money due to historically low interest rates which cause such funds to chase attractive returns. The current conditions in the marketplace mean that the risk reward equation is sound.
- The lack of equity held by Development Groups, as a result of the difficult environment over the preceding four years and therefore the demand for:
- senior debt above bank ratio’s and conditioning;
- where required, equity top up via the provision of Preference Equity.
The market is therefore characterised by Entities providing:
- Preference Equity
- Mezzanine Finance
- Senior Debt
Unlike times in recent history, the sources of this capacity are more private, discreet, disaggregated and also in some cases, of international origin.
There are five major sources currently looking to support the development sector.
- Direct Private Family Money – available for Preference Equity, Mezzanine and Senior Debt.
- Private Institutional Funding – the origin of these funds emanate from Superannuation Funds, and Property Trusts which also aggregate Investor funds usually on a transaction specific basis.
- Aggregation Groups – who have a portfolio of Private Investor Clients that will apply Preference Equity and or Senior Debt to projects on a deal specific basis.
- Private Cash Box Investment Groups – who provide Preference Equity, Mezzanine or Joint Venture capacity on an opportunistic basis. Some specialise in property alone, while others cover the business and the resource sectors.
- International Investment Groups – often in conjunction with Hedge Funds – predominantly originating out of HK, Singapore and the US.
There is no question that in this market the all up cost of accessing funding from these sources is significantly higher than previous non bank sources, however when a total return on hard equity from the Sponsors perspective is measured, the equation is acceptable and most importantly the funding enables sound projects backed by competent Sponsors to proceed.
The position in many ways mirrors the current general business environment, where profit expectations are subdued and the operating business environment is tight.
Development Finance Partners is uniquely placed to access and tailor solutions from all noted sources.
Could your next project benefit from some expert development finance? Get in touch.
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