Attracting project finance for real estate development

by | January 29, 2018 12:45 am



We have all heard the real estate mantra ‘location, location, location’, however, capital is the lifeblood of any investment and this definitely applies to real estate projects. Without capital, you cannot develop real estate however fantastic the location. Equally many projects fail due to a lack of capital. Any developer in pursuit of capital for development is seeking either equity in the form of investment or debt from a bank or similar funder. A developer on the other hand is always looking for funding at the lowest cost, with the minimum up-front financial contribution and the most flexible and cost effective terms.
The equity investor is looking to partner with the developer and share in the project profits at completion when debt and other liabilities have been paid off. As the last party to get paid, equity investors have limited downside protection if things go wrong. However, they enjoy uncapped upside if the deal performs well. A loan provider on the other hand is seeking a secure revenue stream to repay principal plus interest. The loan provider will only provide funding where there is equity in place so that any loss will first accrue to the equity holder before the debt holder. The reduced amount of debt will also make it easier for the project to repay principal and interest from revenues.
Most developers are familiar with equity and debt. However, a third type of fundingis known as Mezzanine funding which is a hybrid financial instrument that sits between equity and debt. The instrument pays out a reduced level of interest to the investor over the life of the project with an additional profit share upon completion or sale of the asset. Mezzanine is attractive to international investors seeking additional security beyond plain equity as theinvestor benefits from a reduced risk profile due to ongoing interest payments and also benefits from the upside potential of the final profit share.
Funders come in many shapes and sizes from banks to insurance houses, high net worth individuals, private equity funds, corporates, international donor institutions and a multitude of other entities attracted to the stable inflation proof returns generated by real estate. Private equity funds and offshore funders seek to fund large projects such as shopping centres, commercial office developments, hotels backed by international hotel operators and other such projects. Local banks will usually fund with debt rather than equityand are attracted to projects with strong sponsorsthat can show a secure revenue stream to be used to pay back the loan. High net worth individuals will fund projects that show a good return above the cost of risk free treasury bills. Insurance houses and asset managers seek projects that can provide a long term inflation-linkedincome stream above the cost of risk free treasury bills that they can use to offset their liabilities.
For any developer seeking funding for a project, certain basic principles apply. For starters, funders will not fund the acquisition of land. At a minimum the developer must bring land with clean title to the table as their equity contribution. For debt, funding is exchanged against title which acts to secure the loan. Without title, there is no collateral to secure the loan. In addition to land, the developer is also expected to contribute cash as their equity investment. This is called having ‘skin in the game’ and gives the investor the comfort that the developer is fully committed to the project’s success and will not walk away if the project is challenged.Additionally, the funder needs to know that the project is attractive to its target market and this is evidenced by pre-sales. Pre sales backed up by depositsreduce the need for external funding hence improving returns. Finally, funders need to know that the developer and his team have the experience to successfully deliver the project on time and within the budget. If a funder is not comfortable with a contractor he may ask that the contractor be replaced with a more experienced one that has a track record of delivery.
Finally, funders require a feasibility study particularly for large projects. A well written feasibility study provides a window through which an investor is better able to view the opportunity presented by a proposed project. Agood feasibility study is far more likely to attract funding from investors than a poor presentation.
Investors will always focus on their return at the end of the project. If the return is not attractive, no investor will invest. In relation to joint ventures, the developer needs to ensure that the JV partner is not over-compensated or there will not be an adequate return for the investor. It is imperative that the developer looks at all the revenue generating aspects of his business – lettable areas, units for sale, land for sale, advertising revenues etc and seeks to design in such a way that revenues are maximised while costs are managed. Costs such as lifts, swimming pools, fittings and fixtures, sub-structure costs etc should be engineered wherever possible to minimise costs while delivering value.
The developer must be open to multiple exit strategies since the market will determine how a deal is ultimately executed. Residential developers undertaking a JV seek to compensate the investor with units. However some investors do not want the trouble of selling units and prefer to receive cash. Exits for larger developments such as hotels, shopping malls and commercial office developments require additional expertise and are usually sold by private equity investors to international companies or funds. In recent times developers have sought to sell commercial office developments on a per floor basis making it easier to sell in the local market.
The good developer has to juggle costs, land acquisition, regulatory issues, funding, design, revenue generation, business requirements and construction and deliver a successful project that meets or exceeds the requirements of the user while at the same time providing an attractive return to the investor. A good developer needs a good team to help his business grow. MCORE is focused on enabling developers succeed and is your trusted advisor in securing funding, structuring and packaging projects and sales and acquisitions for both large and medium sized projects.

 

Munachi Okoye
Okoye is MD, MCO Real Estate (MCORE)

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