The Paradigm Shift in Property Finance

17 September 2018

The Global Financial Crisis (GFC) was a watershed moment for business, and no industry was more affected than real estate and construction. In particular, the way the sector is funded has changed significantly. There has been a paradigm shift, and it's not getting any easier for business operating in this space.

Property finance before the GFC

Prior to the GFC, there was a strong bank appetite to provide all types of finance, and the majority of property funding (particularly for high-rise residential apartments) was provided by financial institutions. Finance may have been approved on a non-recourse basis (without director guarantees) and mezzanine, joint ventures, low equity and first-timers often received bank approval.

While there were some concerns around completion risk and cost overruns, the sale and refinance risk at completion of projects was considered low. There were high levels of competition to provide finance, and assessment included having a Loan to Development Cost Ratio (LDCR) of up to 85 per cent of total development cost.

Moderating bank appetite after the GFC

Then, the GFC happened. APRA started to exert its influence, bank appetite was progressively moderated, and many companies failed. Property risk grade models were strengthened and refined in their measure of the Probability of Default (and Loss Given Default). These models consider (among other things) industry and asset class, years’ experience, track record, expertise, sponsor strength, financial record, equity levels and governance.

This led to an important shift in banks' property risk appetite and financing models. Servicing became more important, LDCR levels dropped to 60-75%, unlimited guarantees from the directors were expected to form part of the security.  Risk grades determined everything (approval, pricing, term, reporting, covenants, security and recourse).

Other changes included demands for recourse beyond the project, a clean ATO position, levels of pre-sale debt cover exceeding 100% and policy restrictions ruling out many otherwise qualifying presales.

10 years on from the GFC: what does property finance look like now?

APRA is now actively involved in influencing bank exposure. It can directly oversee individual files, restrict the percentage of total lending to certain asset classes and locations, and limit interest-only and investment lending, as well as lending to overseas investors. There is also perceived rationing of capital for property via asset class caps.

Essentially, while there has not been major change to policy, appetite has certainly changed considerably. There is little negotiation on price or terms and conditions, and there is a virtual embargo on high-rise residential projects by major banks. Instead, non-traditional lenders such as private funds, family offices, superannuation funds, trusts and crowdfunding has increased.

Tips for property finance in the post-GFC world

The increased level of regulation and oversight is causing banks to look and act in a similar fashion to each other. So, what can you do?

  1. Stay close to your financier and engage early to determine appetite
  2. Understand and address risk grade inputs
  3. Be investor-ready to access alternatives
  4. Carefully choose a project, its viability, location and size
  5. Be flexible and intuitive as to market demand and trends
  6. Understand and mitigate risks, as well as the impact of changes
  7. Seek professional guidance to assist with finance applications and banking relationships.

Property finance dynamics have shifted fundamentally in recent years. BDO's Real Estate and Construction team has been there through all of it, helping property businesses navigate these changing times.  I head up the BDO Debt Advisory team which comprises former bankers experienced in property finance.  We can provide strategic advice on all aspects of property finance, including risk, security, terms and conditions and pricing.   For more information on how we can assist, contact Hung Tran of our Real Estate and Construction team.

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