How are funds raised for Property Development Loans?
MFEG is a major originator for a number of mortgage funds, second-tier banks and investment banks. Our network of capital partners also includes a global hedge fund and several institutional funders, family offices and high net worth investors. We tailor funding solutions to the right capital partners to structure the best possible solution for our clients.
There are numerous sources of capital that can be used when raising funding for property developments. These include: Investment Banks, Family Offices, Pooled Mortgage Funds, Direct Mortgage Funds, High Net Worth Individuals, Non- Bank Institutional Funders, Brokers/ Intermediaries/Originators, Hedge Funds and Hybrids.
Why do developers use non-bank funding for their developments?
If you are reading this you don’t need to be told what banks are, but the definition has expanded somewhat over recent years with many smaller lenders being given banking licences from the Australian Prudential Regulation Authority (APRA). Banks in Australia are also called Authorised Deposit Taking Institutions or ADIs and they are subject to strict capital controls and risk measures which limit the amount of development financing that all but the largest players are able to do.
At the time of writing very few of the smaller banks provide property development finance and the vast majority of loans come from the four major banks. A few of the larger second tier banks will also fund on property development but their criteria is generally in line with the majors.
The best thing about banks is they are cheap. But with this cheap pricing comes a very risk-averse mentality and the bureaucratic process that comes with the hyper-regulated banking industry. The criteria that banks set can be difficult to achieve and it is common for lengthy delays to occur before funding can be finalised.
Investment banks are financial companies that engage in complex financial transactions on behalf of their clients. With strong returns being available in the property finance sector over recent years there’s increasing interest in this space. Most of the development finance coming from investment banks has been at the larger corporate level.
Wealthy families will often have their own office and full-time staff managing their wealth. They are usually looking for higher returns than are generally available with regular investments and the private lending market is where they can often be found. Some families have their own lending companies but many use intermediaries who perform the credit analysis, submissions and manage the administration of the loan for them. Family offices may pool their resources with other family offices or invest in mortgage funds as well as lend their funds directly.
Pooled Mortgage Funds
These funds are raised by investors and pooled into one fund then lent out to borrowers. The benefit of these funds from a borrower’s point of view is that they are usually holding funds on the balance sheet so they don’t need to go out and raise funds for a transaction. They are regulated by the Australian Securities and Investment Commission (ASIC), but the Pooled Mortgage Fund industry was devastated after the Global Financial Crisis when the Rudd Government initiated a guarantee on bank deposits which caused a run of mortgage fund withdrawals. The funds that survived this have since thrived however and it is once again a growing area. The benefit of borrowing through pooled mortgage funds is that the funds are generally already raised and are sitting there so the risk of the lender not having the funds to settle is low. There is also more flexibility with pricing as a pooled fund makes the decision on a transaction and doesn’t need to run the transaction past each individual investor. Investors in these funds are therefore giving the fund managers a greater responsibility than direct funds and therefore these funds tend to be more tightly scrutinised by the regulator.
Direct Mortgage Funds
Direct Mortgage Funds do not pool investors’ money into multiple transactions but raise funds directly for each transaction. When you get an initial approval from such a fund they have usually not yet raised the money but will then put out an Information Memorandum to the investors and will collect the funds for settlement from investors who decide to invest. These funds are also regulated by ASIC but as they mostly deal with “sophisticated investors” there is more onus on the investor to do their own due diligence on the deal.
There are pros and cons to this strategy of fund raising. On the pro side, these funds can be more flexible as they can tailor individual investors to their risk tolerance rather than pool a larger number of investors. It is also a more stable model from a business risk point of view as there is not the contagion risk of one bad transaction affecting the fund’s other investments.
On the borrower side the major risk is that they either don’t manage to raise the funds or that investors pull out of the transaction before the funds are raised. We saw this happen when there was panic in the market during the GFC and at the start of the Covid 19 pandemic. These risks can be managed if funds are underwritten by a balance sheet or a larger fund, or the fund has demonstrated a strong history of transactions. In general, the risk is higher with construction funding than land funding.
High Net Worth Individuals
Some wealthy individuals lend out their funds in order to get a higher return, investing through Direct Mortgage Funds, lending directly, or both. It allows higher flexibility and the ability to move quickly without much red tape, but on the flip side, pricing is often higher. Also, these individuals will often give a higher level of responsibility to their legal representatives to tighten their position from a legal point of view and this can sometimes present an issue from the borrower’s perspective.
Non- Bank Institutional Funders
This category includes any large organisation that lends money from their balance sheet and may include large property groups, hedge funds, superannuation fund managers and the like. Typically, these funds will focus on larger commercial transactions. This category may include hedge funds, large real estate companies, AFSL licenced funds that deal with wholesale investors, or, increasingly, large corporate companies that have started lending divisions. They are companies that are usually lending off their own balance sheets, which provides some surety that funds will be available but are sometimes also subject to the same bureaucratic issues that can affect banks.
Brokers and/or intermediaries will originate transactions for the funders we have discussed. They will usually charge a fee for putting the deal together and going through the funders or they may be paid by the funders themselves for originating the transaction. Some brokers will have formed relationships with high net worth individuals and may even manage the transactions.
You need to use some caution when dealing with brokers (and I say that as a broker) as some will present as direct lenders and may charge high upfront fees with no real ability to manage transactions. A good broker, however, will be across the market and be able to guide you through the various risks and challenges and provide advice as to the best way to structure the loan.
Unfortunately, at this time, there are very few in Australia who provide such a service.
Over recent years, the attractive returns available in property finance in Australia has attracted a number of overseas Hedge Funds into the market both by way of purchasing established Australian funds and lending their own funds.
Many funders may be a hybrid of two or more of the previous categories, for example they may have their own fund but also originate or broker through other funds. They may also co-lend with other funds on certain transactions.