Following continuing pressure by APRA on the major banks to ensure that they comply with their obligations under the Basil III accord, the banks recently reacted by reducing their appetite for construction lending, dramatically reigning in their marketing to developers and in some instances actually reducing the level of staff in their relationship management teams.
This conflict between their requirements to satisfy capital adequacy levels under the accord coupled with their need to improve their return on shareholding to remain competitive with their peers has created a significant problem for many of their developer clientele.
Problem it creates for developers
To achieve their objectives, the banks have raised the bar for developers in terms of their condition precedent requirements, reduced gearing levels and increased their pricing on debt, effectively implementing a flight to quality and leaving many of the their traditional but more marginal clients in terms of credit strength, looking for alternative funding sources.
Dan Holden from HoldenCAPITAL, who was recently awarded #1 commercial broker in Australia, says that this has resulted in a significant shift in the construction lending landscape with some developers quickly adjusting to the need to re-focus their attention on where they source their debt and its not just the smaller more marginalised developers who are making changes.
He says that HoldenCAPITAL is currently settling an average of more than 1 transaction per week but recently there has been a noticeable change in the ratio between the traditional bank sourced debt and those alternative funding options now being opted for by developers who don’t want to miss a market opportunity just because their banks have their own problems.
“In FY15 we settled 64% of our deals with the major banks but this has quickly changed with 62% of the $300mil of project debt settling between now and Christmas likely to be set with alternative funding sources.”
Dan says that through managing the tender process on behalf of its clients, HoldenCAPITAL has been at the forefront of both the bank and non-bank markets and can quickly identify where a client can secure the best outcome for their project needs. He says that the majors are still a strong force in the sector but there are very real alternatives emerging as strong contenders for new projects.
Opportunity for Developers
While there are additional costs associated with these alternative funding sources rising up to the meet the market demand, these alternatives do offer their own distinctly different benefits to developers who do not want to be restricted in their ability to meet identified market opportunities due to the constraints placed on their traditional bank which have no direct relevance to their market sector.
By way of example, non-bank money can cost as low as 9-10% per annum, which, which when compared to the traditional bank cost (if it was available) on a medium sized projects of say 30 product, would add as little as ~$170,000 or 10% variance on normal finance costs to a project with a total cost of $6M.
What this alternative product does offer the developer is the potential for significant savings in other areas such as the opportunity to commence the project without the need for pre-sales. It also allows the developer to lock in a construction price and minimise escalation risk as well as the benefit of selling product which has a more certain delivery date, rather than the more speculative “off the plan” route required to satisfy the banks pre-sale requirements. This in turn gives the developer the edge when selling any completed residual stock, which will be competing with stock still under construction by those competitors who chose the pre-sale option.
Opportunity for Investors
Dan also commented that the changing landscape in the construction finance arena has also given rise to an increase in private investors looking to invest in development opportunities. With the uncertainties surrounding the investments in shares, reduced superfund returns and tightening investment yield in investment property, investment in well structured and risk mitigated developments was providing investors with a very attractive alternative. We currently manage over $70mil of private investor funds and the enquiry from new investors is getting more frequent.
So what is the future for construction lending? There is no doubt that many of these changes have been seen before but the reality facing the banks is that many of the revisions driving how they participate in the construction market are permanent rather than the cyclical as in the past and as such, it would appear that the rise of the alternative lenders is more than a passing fad and could represent a real paradigm shift in this sector.
|This article was written by Dan Holden of HoldenCAPITAL, who are a bespoke construction finance firm; they arrange construction finance and invest in projects through their equity fund, Queen Street INVEST. To discuss your project finance requirement please call (07) 3171 4200 or visit www.holdencapital.com.au|