Prior to the GFC, there were plenty of options available for raising capital to get development projects off the ground, with the onset of the GFC, most players in this space retreated back overseas, went missing in action or went bust. This has left developers starved of risk capital. As a result, a lot of good projects didn’t take off.
Financial Services Partner, Miles Anderson, says that over the past few years, he’s had plenty of conversations with large cashed up developers who have indicated that sites are cheap (if you can find them) and the banks are throwing money at them. It has been an entirely different story for those that are not at the big end of town.
The good news is that alternative funding options are back. We are seeing a lot more instructions involving mezzanine finance and preferred equity deals. These instructions are coming form existing clients that have come back into the market and from new entrants. Family (ie private) funds and institutional funds are now active. Major banks are also becoming more aggressive in their lending policies.
The supply of development stock is improving. Banks and fund managers who have been sitting on distressed assets (particularly greenfield sites and partly completed developments) are now actively attempting to exit their positions. They are being more realistic in their price expectations and, as well as going to market on single assets, are affecting portfolio sales of their bad loans. These portfolio sales are providing great opportunities for developers. With the pain of the write off having been taken by the original funder, coupled with an increased appetite for risk on the part of new funders, developers are doing deals either on outright purchases or structured arrangements with the new funder.
Things haven’t quite gone back to the way they were pre GFC. Funders are being more careful in the projects they will fund. Due diligence on projects has to stack up. Funders at all levels are also employing property experts to assess deals and provide ongoing monitoring of projects in addition to their usual credit processes.
Given our current low interest rate environment, mezzanine funders are also looking at different ways of achieving their desired return. Mezzanine funding rates of 25%+ are being replaced with coupon rates of 15%-18% plus profit share.
Another influence on the structures being set up is the attitude of primary funders. First tier lenders are imposing onerous conditions on any consent they give to mezzanine funding, with some banks outright refusing to consent to any security being granted to a mezzanine funder. This has led to transactions having to be structured such that the mezzanine funder takes an unsecured or equity position. Without security, the risk profile for the deal changes and consequently so does the return a mezzanine funder will require. Given the very different attitudes among first tier lenders as to how risk capital is raised, it has become imperative that developers consider a funder’s policies on risk capital and their blended cost of funds before selecting a primary funder.
While it is premature to say we are back in a sustained growth cycle, the shoots are definitely there. The rules have changed a bit, and like the footy, we will have to wait and see whether the rule changes are good for the game.