Transaction news: March 2014
Funding considerations in Australia for 2014
- 7 things you need to consider in order to secure funding
- Red flags: what to look out for
- Sealing the deal
Availability of traditional bank funding has continued to increase over the past 12 months in line with the stabilisation of core market sectors. However, Tier I lenders continue to demonstrate a selective focus over the management of exposure and risk in line with the tighter regulatory capital controls being imposed.
A selective appetite for funding risk highlights the importance for developers to present funding proposals in the most effective and impactful way. This is to give projects the best chance of procuring an optimum funding outcome.
Quality of the sponsor, product and the sector remain a primary consideration for funders. Generally, projects must have the necessary approvals prior to settlement of senior debt facilities, or at least be close to achieving them. Longer-term land projects contingent upon planning approvals and/or re-zoning still require alternate means of finance or equity. An understanding of the current funding market is therefore paramount to procuring the best funding terms.
“Developers all in funding costs for their property development projects are finally falling due to an increase in competition by senior debt providers and greater access to mezzanine and equity funding providers. This article explores the changing sentiment in market appetite for quality sponsors with quality projects, which we believe will continue as new entrants from Asia come into the market,’ says EY Director, Luke Mackintosh.
Key considerations for sponsors seeking to fund real estate development projects include:
- Minimum equity requirements
Minimum levels of equity continue to differ from project to project, and are generally dictated by credit policy, the risk profile of the transaction and the ability to mitigate risks.
An understanding of the likely minimum levels of equity required, what constitutes equity and the timing of payment are paramount in establishing a meaningful funding strategy.
- Market-based feasibility model
When preparing to seek funding, a relevant market-based feasibility model should be prepared. The model must reflect real or qualified line items, and demonstrate the necessary minimum level of return required by the bank for the type of project and sector.
Line items should be relevant, and costs/ fees suitably benchmarked for the funder to analyse against past projects. A bespoke funding model submitted for this purpose demonstrates the sponsors sophistication and understanding of the key financial inputs relevant to the funder. Back of the envelope calculations are no longer acceptable and can impact the sponsors funding credibility.
- Facility covenants and conditions
Developers should be aware of minimum requirements and covenants including preconditions. An understanding of the typical requirements regarding pre-sales, builder engagement, insurance and other material agreements relevant to the project will avoid latter delays or re-documentation when seeking funding.
Once these are locked into a finance agreement, variations may be costly, and cause significant delays in project drawdowns or construction. Any agreed conditions, timing and costs with the funder should be achievable and mirrored appropriately in the cash flow.
- Security and recourse
Personal recourse remains a contentious issue, and a standard condition of most bank funders. It can be waived in appropriate circumstances dependent upon the project risk profile, and other collateral security.
- Finance costs
Costs include but are not limited to application/establishment fees, line fees, interest/discounted proceeds, settlement and discharge fees, and bank due-diligence costs. Due-diligence costs typically cover independent valuation, solicitor, engineer and Quantity Surveyor (QS) costs. However, strategic planning and understanding of the requirements may identify synergies to mitigate these costs.
A current valuation is also considered a critical component to securing any type of financing. Where possible, interest rate mitigation strategies should also be given particularly for longer term projects.
- The funding proposal
Selective appetite by Tier l lenders highlights the importance of preparing an effective funding pack to present the project with the best chance of achieving optimum and timely outcome.
Funding packs vary with the complexity of the project, but should at a minimum clearly outline the project and sponsor capability, the facility required and tenor, and the payout mechanism. It can be prudent to highlight material risks for early discussion, but the proposal should be based on ‘market-achievable’ terms, and highlight any non-negotiable points by the sponsor.
- Equity, hybrid or mezzanine funding
Structured correctly, equity, hybrid or mezzanine funding can be stacked with traditional senior debt to enhance return on capital and reduce exposure. Mezzanine and preferred equity has been used increasingly post 2011 by developers to address the higher equity requirements of senior debt lenders.
While banks remain cautious of this additional tier, demonstrating full subordination, established inter-creditor precedents, and adequate management capability can quell concern.
Common issues, or red flags, that we often see experienced by developers seeking funding include:
- Inappropriate feasibility model and lack of detail over key funding risks
- The outlined development return less than minimum expected by funders for project type
- Missing or non-justified line items and costs in cash flow
- Lack of material recourse or underwriting security to support the transaction
- Unacceptable pre-sale contracts (documentation, overseas and multiple purchasers, deposits)
- Unacceptable delivery and management capability of sponsor and/or project team
- Incorrect equity assumptions
- Necessary information and approvals not ready for funder due-diligence
- Principal pay out and project time frame unclear and/or unachievable conditions and timeframe within cash flow
- Legal structure too complex for nature of project
A selective marketplace highlights the importance of a relevant and effective funding proposal supported by the correct information. It is beneficial for developers to consider non-traditional funding options.
“Exchanging funding options to include mezzanine/equity funding provides the developer with resources to purchase their next site. Without a healthy and stable pipeline of projects, the developer’s business will not grow. This equity swap delivers the security that many developers seek to build a sustainable pipeline of projects,” says EY Director Luke Mackintosh.
Early consideration of funding requirements into relevant documentation and approvals will ensure a smooth transition in securing traditional and non-traditional lenders.