Real estate development: change in the financing model
The Australian property market is a potential time bomb with residential investors increasingly focusing on capital appreciation for returns, while commercial property transactions have actively pursued performance-based investments for the past 12-18 months. The real estate market seems driven by high interest from overseas investments and local investors and developers charged. The short- and medium-term outlook for interest rates appears to be positive, but in the longer term there is the expectation of an increase in rates: tighter interest rates from banks are coming into play and access to financing for development is not as optimistic as before.
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 the global policy changes that occur around the movement of capital outflows such as China. According to Knight Frank, China-backed developers bought 38% of Australia’s 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. The key aspects will be considering development design, construction services, and fabric costs. Reducing development costs to these figures may demonstrate the opportunity to expand the funding budget and potentially seek specialized funding sources.
The cost of financing may increase on the debt side, but if investor capital is expensive, increasing LVRs available with private funders could provide net decreases in the overall cost of capital. The ability to access this financing without pre-sale 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 builders and developers profits. Less consideration and emphasis is placed on the operation and ongoing liabilities of the new development.
The new model
What if we could add all these extra extras to create a better performing asset with lower operating costs, but without having to increase the capital budget? In fact, lower our cost of capital by accessing Green Structured Finance (GSF), available long-term financing, subsidized by financing specialized products. This new loan / debt will be covered by the operational savings achieved by the improved technology and products.
For example, a developer is building and owning a $ 50 million mixed-use site. We consider the design and energy consuming technologies for the site (i.e. lighting, solar, metering / integrated 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 return on investment based on expected energy costs. For this example, $ 5 million is deducted from the project capital cost for the enhanced package. This will reduce the Capex and Opex of the developers, improving the cash flow and returning the profits. This reduction of $ 5 million or 10% can be used in other projects or contribute to improving the project’s LVR and financial composition.