With a long summer continuing to dominate the Australian East Coast, the hot topic in many developer boardrooms and air-conditioned cafés is, where is the funding for our next deal going to come from? 

In our first quarterly update for 2017 we bring you our views on the emergence of new funding options along with where we see the markets trending, and what you need to do to get to the front of the queue with your next project to ensure that your 
funding is secure.

Residual stock borrowing opportunities

The inner-city apartment markets across the eastern seaboard has been experiencing an interesting time over the past three years. Across the capitals of the eastern seaboard, we have seen tremendous price growth in Sydney, and to some extent Melbourne, and in the case of Brisbane, we have seen unprecedented high sales rates and volumes.

That said, over the past 6–9 months we have identified, while the price points have remained relatively stable for inner-city apartments, it is the rate of sale that has slowed dramatically.  

The impact from this slowdown in sales rates is that we are starting to see many projects with surplus unsold by completion, and this is creating certain complications for the developers of those projects given that:

• Most projects carry a significant portion of construction debt funding, which by definition is required to be repaid on completion of the project. So, in these cases, if the developer does not have sufficient sales to repay the construction debt at completion, they must refinance the balance.
• Even if there are sufficient sales to repay the construction debt at completion, the developer may want to raise funds against their equity in the remaining stock in order to reinvest that equity into their next project.

For these reasons, we are seeing an increase in enquiries for residual stock facilities.  

Depending on the developer’s strategy, there are various options available in the market for residual stock facilities. As a rule of thumb, the term and gearing of the facility are directly related to the cost of the facility i.e. a 20-year home loan style loan is typically much cheaper than a 6-month bridging loan.

Common success strategies we are often able to secure are:

• The developer intends to retain the residual stock for a long-term investment period (more than 5 years). Reasons for this might include, no GST liability, no sales commissions on those units. Effectively, under these circumstances we can arrange a residual stock facility at a relatively low cost of funds, say <5 per cent per annum at a loan to value ratio of between 60 per cent and 70 per cent enabling the developer to access their equity currently locked up in the project to reinvest into their next project.
• The second scenario sees the developer wanting to progressively sell down the residual stock, but in an orderly fashion.  This will ensure they are not rushed by a construction lender needing to be repaid and enables them to maintain and potentially improve the capital value of the stock.  

In these cases, we can arrange a 6–9 month bridging facilities, which provide the developer with sufficient time to undertake an orderly sell down. Bridging loans are more expensive due to the shorter period and are typically priced at an interest rate between 8 per cent per annum and 12 per cent per annum at a 70 per cent LVR. Advantages here are that there are no early payout penalties and the facility allows the developer to retain some of the proceeds from each sale rather than waiting until the lender is fully repaid, as these bridging loan lenders do not require full net proceeds when settling the units, provided their exposure is progressively improving.

There are of course many variations on these two basic strategies, so the best course of action would be to let us have a look at your individual requirements and assess how we can structure a custom solution to satisfy your individual project needs.

The rise of non-bank lenders

Back in November of 2015, HoldenCAPITAL had some 97 players on its lender list, comprising the four major banks, some 18 minor banks, and a mix of institutional lenders, investment funds, mezzanine, and private lenders, most of which were largely inactive. 

Back then, the four majors accounted for around 67 per cent of the $250 million in transactions we settled. As we moved through 2016, this balance shifted dramatically with the majors slipping to around 28 per cent of the $340 million that we settled in FY2016 as the APRA restrictions bit into their appetite. A quick review of the business settled for the FHY2017 sees that this has fallen to below 20 per cent, and we don’t expect this will change anytime soon.

So who is actually doing the deals? Our lender list currently stands at 164; an increase of almost 75% in the total listings since FY2015 and it’s increasing almost on a weekly basis. The big gains have been amongst the investment funds and private lender sectors, with the fund list growing by 54 per cent to 71, and the privates by 250 per cent to 35.

This demonstrates how the market is evolving to meet the demands of developers. While they are filling the gap left by the majors, many of these lenders have very restrictive loan requirements in order to manage their relatively small pools of capital. This means that navigating your way through the new lender pool is time consuming and difficult if you don’t know in advance the appetite of these lenders.

There is much talk about offshore lenders/investors entering the market place and we have been talking to a wide range of existing and prospective participants over the past eighteen months with Dan Holden and the team undertaking some four trips to Asia which has revealed that their actual willingness to do deals is quite limited. Many are keen to participate, but it takes time for them to build a comfort level with our diverse geographic markets and associated risks, so for now they are proceeding on a very cautious basis.

With the existing non-bank lenders in significant demand and successfully expanding their books, you might expect this growing level of choice and competition to create pricing competition however, the reality is a little different. These established lenders have generally moved to improve the quality of their loan books and effectively reduced their level of risk/exposure in the capital stack. However, they have done this while maintaining, and in some cases slightly increasing their pricing, which provides them with a better return on equity and an improved risk rating while still being competitively priced.

Many of the new lenders entering the market tend to be asset focussed and make decisions based on a pragmatic understanding of the markets and the product being developed. Provided the sponsor risk is acceptable, they will fund them but at a price. Rather than being uninformed like so many of the lenders entering the market during past market disruptions, many of this new raft of lenders understand how to price capital and are far more cautious than their predecessors.

So the challenge for today’s developers is to navigate their way through the vast array of lending options and be able to negotiate the best available terms. A quick “no” is certainly far better than a quick “yes” followed by a laborious DD process ending in a “no”. With many of the new entrants still building their infrastructure, there is the potential for a mismatch of expectations between lender and developer. The team at HoldenCAPITAL is constantly qualifying our lender list to ensure that the needs of our clients are met promptly and with confidence.

Click here to read HoldenCAPITAL's Autumn 2017 Quarterly Update.

This article was written by Dan Holden of HoldenCAPITAL, a bespoke construction finance firm. HoldenCAPITAL arranges construction finance and invests in projects through their equity trust, HoldenINVEST. To discuss your project finance requirements please call (07) 3171 4200 or visit www.holdencapital.com.au.

This is a sponsored article.

Read more from HoldenCAPITAL:

From DA to digging a hole

New HoldenCAPITAL report describes non-bank funding landscape

Diversify your risk by partnering as a passive investor

When does sweat equity via uplift in land value count?

Why the banks fear foreign pre-sales

Risk & reward: Does more debt solve your problems or do you need a JV partner?

What is mezzanine funding?

Don't forget your GST obligations when arranging your project finance

Why the bank won't let you have a second mortgage