AAA Financing In Real Estate

It’s a common occurrence for developers to obtain land, receive planning permissions and start on preliminary and even construction work before thinking seriously about financing.
As a result we often come across interesting and once promising projects that have now become long-term endeavors due to the negligence of developers who didn’t pay enough heed to financing at the start of construction. In order to avoid this kind of scenario, experienced and prudent owners first calculate the payback period, create more than one possible financing model, consult specialists and only then switch to planning and construction.

But what are the financing options for developers? Generally a developer can choose from the following options:

• direct financing
• finding a co-investor
• bank loans
• obtaining financing on the open market

It should be pointed out that each of these options comprises a number of possible variations. For example, loans can be provided by one bank or a banking syndicate. Likewise a co-investor can conclude an agreement that includes the sale of investment rights to a future building. However the following classification is generally deemed the most logical and clearly understandable:

• direct financing – developer controls the entire process
• following the sale of a large share to a co-investor the developer has to share its control powers
• bank loans are obtained and the developer has to strictly account for the use of loaned funds

Let’s examine each of these financing options in more detail. It would seem that the best option is the one in which the developer has sufficient funds to finance construction independently. However, any experienced finance manager knows that when calculating project efficiency for direct financing, other investment options must also be taken into account, since the failure to benefit from possible loans can severely curtail company’s development opportunities. Additionally, even when a developer has considerable funds at its disposal these are rarely enough to develop all projects simultaneously. On the other hand, it should also be pointed out that direct financing is the least risky option. The absence of external investors means the lowest possible risk of losing control.

Finding a co-investor is the best option if the owner’s funds are too limited to obtain a bank loan. A lot of buildings are now being built under co-investment agreements. However co-investors generally prefer to join the project at a later stage when the building shell has already been built. Consequently financing for pre-planning and development still has to be done independently.

It’s well worth pointing out that if the co-investor is a large organization then it will often apply to a bank for loans to finance the areas acquired in a future shopping or office center. Banks are usually more than willing to finance these kinds of projects since the involvement of a well-known company with a sound reputation constitutes an additional repayment guarantee. An increasingly popular option is using bank loans to finance construction without recourse to a co-investor. On the plus side the developer remains essentially in charge of the project since the bank’s only task is to recoup its loan plus interest. However the developer must make sure it obtains financing at a reasonable cost and repayment term. It is now becoming easier to obtain bank loans. There are indications that competition will mean that banks start offering more flexible financing including mid-term construction loans and long-term financing for running completed buildings.

It is commonly believed that obtaining a bank loan means compiling a lot of unnecessary documentation. I will try address this fallacy in my future articles but for now let me just point out that the remit of bank managers scrutinizing projects should only extend as far as the likelihood of loan repayment. So the primary consideration here is the project’s viability. Obtaining financing on the open market is currently something of a rarity in the Russian development market. The only financing vehicles used by large companies to date are CLN’s or bonds. The financial directors which choose this option are no doubt attracted by the fact that these funds are obtained on the open market which frees them up from fulfilling specific project obligations. However, there are some restrictions (covenants) that affect the workings of the issuer. It is believed that as the finance market develops we will see more and more of this type of financing.

So finance managers in development companies are faced with a difficult choice related to the best financing scheme for their new projects. I have briefly presented the options available. Each of them has its own unique advantages and disadvantages. In the future I will talk in more detail about each of these financing alternatives.