Finally filling the funding gap

Since the credit crunch began some five years ago, the availability of funding across the board has reduced dramatically as a result of the major banks’ withdrawal from markets and their need to reduce loan exposure and loan book sizes in many areas.

This funding gap has started to be filled by numerous new lenders, with sources of new funds coming from a variety of entities that include private equity, corporate and institutions.

However, such sources, while relatively numerous, collectively result in a small quantum of funding when compared to the sheer volume of funding that was freely available pre-crash. That is not entirely a bad thing, given that it was the absolute volume and easy availability of credit of all types at unsustainable levels and low cost to borrowers that fuelled the boom and partially created the problems in the first instance.

Indeed, the market is clearly attempting to balance itself with the volume of transactions that are viable and also substantially reduced in quantum. Therefore one needs to be careful not to simply focus on just one side of the equation – i.e. volume of lending.

This has been highlighted by the obstacles encountered by some new non-bank lenders who have had difficulty in deploying the volume of funds they anticipated within the timescale needed to ensure the return on funds needed.

The variety of lenders that are in and entering the funding market has resulted in a very fragmented market with a broader range of finance types and options available for developers than for some time. These fall broadly into the following categories although within each group there are a wide range of terms and costs. Indeed, the costs are not always apparent to the uninitiated and may not necessarily be of a purely financial nature – speed of decision making, proven ability to perform and people who truly understand property and its idiosyncrasies should all play their part in matching the most appropriate form of funding to any given situation.

Senior debt

This is primary funding secured on a first charge basis against the asset, normally with limited recourse to the principals by way of directors’ guarantees etc. The typical level of senior debt available equates to 55 per cent of the Gross Development Value of a scheme, often equating to around 65-70 per cent of total costs. Interest rates vary from base +3.5-5 per cent, with many banks applying a minimum rate of 7 per cent per annum. In addition, commitment fees of 1-1.5 per cent and exit fees of 1-1.5 per cent are fairly standard.

Mezzanine finance

This is generally provided by a specialist lender and sits on top of the senior debt facility. The loan is secured by means of a second charge over the asset combined with limited recourse by way of guarantees from the borrower.

The cost of this funding is typically 25-30 per cent per annum to reflect the higher level of risk associated with such lending. Loans are generally available up to 70 per cent of Gross Development Value (when combined with senior debt) taking total funding up to 90 per cent of total costs. This can substantially reduce the equity required from a borrower and increase the return on that capital invested, assuming a project performs as expected.

Stretched debt

A number of lenders are providing a ‘stretched’ or enhanced debt facility that provides a combination of senior debt and at least a portion of mezzanine, typically up to around 85 per cent of total costs. The costs of this are generally around 15 per cent per annum through a combination of fees and interest.

Equity/joint venture

This is scarce compared to the other categories but there are a limited range of options that can provide joint venture type funding for developers wishing to take advantage of opportunities they have but where existing capital is fully committed to other schemes. Costs of any

funding of this nature can vary substantially dependent on the risk profile of the project but typically borrowers should expect no more than 50 per cent of profit from a project if a partner is taking the full financial risk.

The most critical common thread between

all aspects of funding in the current market is the track record and experience of the borrower. This is of paramount importance to all lenders and, in our experience, the most successful developers are those with a very focused approach in terms of geographical location and/or nature of projects undertaken.

Lenders realise that all parties involved in projects have to use their best judgement, supported by professional advice as appropriate, in terms of likely sales values that can be achieved for the product and that many factors outside anybody’s direct control can affect this. However, the risk of having a completed product delivered should be mitigated by working with developers with appropriate experience and proven ability to deliver similar quality schemes.

From the borrowers’ perspective, when assessing the funding options that might exist for a scheme, one key aspect is for developers to ask themselves what is most important to them in a funding structure – i.e. is it ultimate cost of funding or reducing the equity they are required to invest to ensure they have adequate capital available to spread across other opportunities, acquire options, bring new schemes through planning etc?

In conclusion, funding is available for borrowers and projects of appropriate strength but navigating through the myriad of options available is probably more challenging for borrowers than it has ever been. The structuring of the most appropriate funding solution for projects has never been more important for all involved to ensure success for all parties involved.