Funding Chaos
If property is the body then finance is the bloodstream. Since the GFC and now with Covid19 the funding stream has a bad case of blockage and is threating the industry as a whole.
What can we do?
In simple terms property finance (both development and investment) is made up of two components, Debt and Equity. Equity can subsequently be split into different sources including –
· Mezzanine funding
· Preference Equity
· Asset Equity
· Cash Equity
After the GFC the biggest issue facing the industry was that Tier one banks reduced their Loan to Value Ratio’s (LVR) from around 80% to around 60%. That extra 20% must be made up in the equity component. This led to an increase in Mezzanine Funding arrangements.
Now mezzanine funding must be treated with respect. It is expensive at anywhere between 12% to 20%, but is attractive when compared to returns on equity of 40%. However mezzanine funding can chew its own head off with capitalising interest if left too long. Mezzanine funding works for a commercial project with committed quality tenants, which allows a reasonably quick sale on completion. I do not recommend it for residential projects that rely on sales of residential apartments or houses to clear debt. For example compare a fuel and fast food project to a 12 unit complex. Simply put, the fuel and fast food requires one buyer to clear debt and create profit…the residential project requires 12 separate buyers.
In saying that Mezzanine Funding is a critical medicine for the industry, but it is treating the symptoms and not the cause. The cause however is inherent in the market forces approach to our capitalist economic system. Now I’m not saying that our finance system is broken or that there is a better way of doing things. What I am saying is that education is the key. Understand how the system works and make it work FOR you not AGAINST you.
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