Real estate development – Changing the financing model
The Australian property market is a potential time bomb as residential investors increasingly focus on capital appreciation for returns, while commercial property transactions have actively sought performance-based investments over the last 12-18 years. months. The real estate market seems driven by strong interest from offshore investments and local investors and developers who have cashed in all the way. The short to medium-term outlook for interest rates appears to be positive, but in the longer term there is an expectation of rising rates: tighter interest rates from banks are coming into play and access to financing from the development is not as promising as it once was.
Institutional lending restrictions will become a growing problem as major banks must reduce their exposure to major real estate markets. The market is also adjusting to the tightening of foreign buyers and global policy changes occurring around the movement of capital outflows, such as China. According to Knight Frank, Chinese-backed developers bought 38% of Australian residential development sites in 2016.
Developers/Builders: The Challenge
Developers appreciate that there are still significant opportunities in the market, but the challenge now lies in accessing capital and potentially seeking non-bank sources of capital. Key aspects will be to consider the design of the development, the construction services and the costs of the structure. Reducing development costs to these numbers can demonstrate the opportunity to expand the funding budget and potentially seek specialized funding sources.
The cost of financing could increase on the debt side, but if investor capital is expensive, increasing the LVRs available with private funders could result in net decreases in the total cost of capital. The ability to access this financing with no presale fees makes it a desirable option for smaller developers.
Buildings are typically designed and built to minimal code, eliminating the cost of all the bells and whistles to maximize builder and developer profits. Less consideration and emphasis is placed on the operation and ongoing liabilities of new development.
the new model
What if we could put in all these extra extras to create a better performing asset with lower operating costs, but not have to increase the capital budget; in fact, reduce our cost of capital by accessing Green Structured Finance (GSF), long-term financing? available, subsidized by specialty product funding. This new loan/debt will be covered by the operational savings realized by the improved technology and products.
As an example, a developer is building and owns a $50 million mixed-use site. We consider design and energy consumption technologies for the site (ie lighting, solar, integrated metering/grid, thermal insulation, glazing performance, energy efficient appliances, hot water, HVAC).
SFG assesses the ongoing life cycle cost of these technologies. We then create a package that outlines which products have an attractive ROI based on anticipated energy costs. For this example, $5 million is deducted from the project’s capital cost for the upgraded package. This will reduce Capex and Opex for developers, improving cash flow and generating profits. This $5M or 10% reduction can be used on other projects or contribute to improving the project’s LVR and financial composition.
