A new real estate development model is challenging the Big End of Town

Real estate development – change of financing model

The Australian property market is a potential ticking time bomb as residential investors increasingly focus on capital appreciation for yield, while commercial property transactions have been actively pursuing yield-based investing over the past 12-18 months. The real estate market seems to be fueled by strong interest from offshore investments and local investors and developers. The short- to medium-term outlook for interest rates looks positive, but longer term rates are likely to rise – bank rate hikes are coming into play and access to development finance is not as rosy as it used to be.

Constraints on institutional lending are becoming a growing concern as the big banks have to reduce their exposure to real estate leaders and markets. The market is also adjusting to the tightening foreign buyers and global policy changes taking place regarding the movement of capital outflows like China. According to Knight Frank, Chinese-backed developers bought 38% of Australia’s housing estate in 2016.

Developer/Builder – The Challenge

Developers appreciate that there are still significant opportunities in the market, but the challenge now is accessing capital and potentially looking for non-bank sources of capital. The focus is on the consideration of the development concept, building services and construction costs. Reducing development costs to these numbers may reveal an opportunity to expand the funding budget and potentially seek specialized funding sources.

Funding costs could increase on the debt side, but if investors’ equity is expensive, increasing the LVRs available at private lenders could result in a net reduction in the overall cost of capital. The ability to access this funding with no pre-sale quotas makes it a desirable option for smaller developers.

Typically, buildings are designed and constructed to minimal code, eliminating the cost of all the bells and whistles to maximize builders and developers’ profits. Less attention and emphasis is placed on the ongoing operations and liabilities of the new development.

The new model

What if we could add all of those extra extras to create a better performing facility with lower operating costs, but didn’t have to increase the capital budget – actually lower our cost of capital by accessing Green Structured Finance (GSF), long-term financing available, subsidized by subject-specific product funding. These new loans/debts will be serviced by the operational savings realized by the improved technology and products.

For example, a developer builds and owns a $50 million mixed-use site. We consider the design and energy consuming technologies for the site (e.g. lighting, solar power, metering/integrated network, thermal insulation, glazing performance, energy efficient appliances, hot water, HVAC).

SFG evaluates the ongoing life cycle costs of these technologies. We then create a package that shows which products have an attractive return on investment based on projected energy costs. For this example, $5M is subtracted from the capital cost of the project for the upgraded package. This will reduce developer capex and opex, improve cash flow and return profit. This $5 million or 10% reduction can be used for other projects or help improve project LVR and financial composition.