Pricing for Risk in Australia’s Construction Finance Market: Bank vs Private Funding Options

Pricing for Risk in Australia’s Construction Finance Market: Bank vs Private Funding Options

Bank Credit Parameters for the Construction Sector have tightened; however Private markets can plug the gap by pricing for risk.

Australian Banks’ Changing View on Construction Sector Finance

The Australian Banks reduced appetite for Construction Finance has been well publicised. The are several contributing factors for this and they include:
1.     A fundamental decline is presale sales rates.
2.     Heightened settlement risk and concern pertaining to the Banks’ existing exposures created by, amongst other things, the Banks’ own Retail Banking Divisions slowing the rate and volume of lending to property investors and owner occupiers, declining valuations at settlement and a lack of funding for FIRB purchasers.
3.     From a perspective of return on equity, development finance is not as attractive/profitable when compared to other financing opportunities such as lending to going concern businesses which have sound maintainable earnings with high transaction volumes.
4.     The short to medium term fundamentals have declined in the markets where construction finance approvals have been historically high in recent years.

Impact on the Australian Construction Sector Financing

The impact of this change in view has included the following:
1.     More stringent credit risk assessment especially with respect to new to bank clients
2.     Reduction of loan to value ratios reduced from 80% TDC to 65%-70% for construction finance.
3.     Landbank facility approvals are exceedingly difficult to obtain any LVR.
4.     Increased presale levels from 50% to as high as 120% debt cover
5.     Increased complexity with respect to credit assessment and approvals
6.     Slower timeframes for approval and settlement
7.     Increased financing costs due to increases in Loan Establishment Fees, Margin and Line Fees
8.     Facility limit approvals greater than $20m are becoming increasingly more difficult to obtain
9.     Not recognising foreign investors as a qualifying presale
10.  Pulling back and/or not lending to foreign investors and developers

Pricing for Risk in Construction Finance

Australian Banks Don’t Price for Risk

The combination of the above from all the major and secondary banks has had a significant impact on the ability of projects to get out of the ground.  Developers that once needed equity of 20% of project cost are looking at equity requirements of 30% minimum.  The presale hurdle also means that funding is delayed while presales are achieved in a softening market.
Declining site values, increased construction and sales costs have resulted in even further increased levels of equity requirements and put downward pressure on the viability of many projects.
The policy shift only serves to increase the likelihood of a property correction.  Australian Banks offer relatively low interest rates and DO NOT price for risk.  They could easily raise their interest rates which would enable them to consider quality projects at slightly higher LVR’s and/or lower presale hurdles.  Conversely when the market has been through a correction, they generally compete with each other for market share and help to create an environment for the next property surge.

Private Funding Can Price for Risk

The Private Funding market provides a buffer by PRICING FOR RISK.  Over the past twelve months there has been new private fund managers entering the Australian market to take advantage of the gap created by the Banks.  The price differential is offset by the lower presale hurdles, the higher loan ratios, the speed to approval and the speed to settlement.
DFP recently sourced private funding for a quality project in Chermside, Brisbane. The funding a mix of Bank debt with a layer of Mezzanine funding. The combined LVR was 90% of total project cost.
The Private funding market serves to plug this gap as evidenced by DFP recently securing funding for a site in Melbourne at 65% LVR (loan amount $12.2M). The site zoning was code assessable however DA was yet to issue; and due to historical use had contamination issues.  This was another example of PRICING FOR RISK.

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