How to Finance a Real Estate Development Project?
It takes a certain personality to be able to cope with the “high risk, high reward” investment of real estate development financing. Behind every project is investors, lenders, contractors, purchasers and other stakeholders who all need to be aware of the risks and manage them responsibly.
With more than two decades in the industry, we at MFEG have seen many deals go well and fortunes made, but a small number of deals have gone bad. Being involved in private lending, we’ve also been tasked with helping save developments experiencing problems by arranging emergency capital.
These are heartbreaking experiences, as the financial and/or costs to developers, investors, contractors and other stakeholders and mental stress that goes with this can be devastating. This is why, for those wondering how to start a real estate development project, it’s important to know your finance options and the pros and cons of each.
Financing your real estate development project through the bank
The definition of a bank has expanded somewhat over recent years, with many smaller lenders being given banking licences from the Australian Prudential Regulation Authority (APRA).
However, given that banks are subject to strict capital controls and risk measures, only the largest players can achieve development financing - the vast majority of loans come from the four major banks. A few of the larger second-tier banks will also fund property development, but their criteria are generally in line with the majors.
The main pro of using a bank to fund your development is that the pricing is very cheap. But with this affordable pricing comes a very risk-averse mentality and the bureaucratic process that comes with the hyper-regulated banking industry. Put simply: bank funding might be a more affordable option, but less flexible and far more time-consuming.
Investment banks are another avenue
These are financial companies that engage in complex financial transactions on behalf of their clients, and with strong returns being available in the property finance sector over recent years, there has been an increased interest in this space. Most of the development finance coming from investment banks has been at the larger corporate level.
Family offices of high net worth individuals
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 one that provides such opportunities regularly.
Some of these families have their own lending companies but many use intermediaries who perform the credit analysis and submissions, and generally 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 from investors and pooled into one fund, then lent out to borrowers.
From a borrower’s point of view, the benefit of a Pooled Mortgage Fund is that investors are usually holding funds on the balance sheet, so they don't need to go out and raise funds for a transaction. The funds are already there, and they are regulated by the Australian Securities and Investment Commission (ASIC).
The other advantage of Pooled Mortgage Funds is that each transaction doesn't need to be run past each investor – therefore, pricing can be more flexible.
It’s worth noting that 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 though, and it’s once again a growing area.
Direct Mortgage Funds
Rather than pooling investors’ money into multiple transactions, a Direct Mortgage Fund raises the funds directly for each transaction. When you get an initial approval from a Direct Mortgage Fund, they have usually not yet raised the money. However, they will then put out an Information Memorandum to the investors and collect the funds for settlement from investors who decide to invest.
ASIC also regulates these funds, but as they mainly deal with “sophisticated investors”, there is more onus on the investor to do their due diligence on the deal.
There are pros and cons to this strategy of fundraising. On the pro-side, these funds can be more flexible as they can tailor individual investors to their risk tolerance rather than pool a more significant number of investors. It’s also a more stable model from a business risk perspective, as there is no contagion risk of one bad transaction affecting the fund’s other investments.
The major risk is that they either don’t raise funds or that investors pull out of the transaction before the funds are raised on the borrower side. We sometimes see such scenarios occur when there is a large panic in the market, such as the GFC or the start of the 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.
At MFEG, we have a wealth of experience helping investors and developers navigate these risks and give their project the best possible chance of an optimal outcome
We know who is in the market for what type of project and developer on any given day, and we understand the criteria they focus on when making investment decisions.
We facilitate a wide range of borrowing opportunities for all stages of a project’s life cycle, ranging from site acquisition through to construction and completed stock. We can provide access to senior debt, mezzanine debt and equity capital on flexible terms at attractive pricing not typically available via traditional lending avenues.
For more information, get in touch.