Capital partnerships work best when parties want the same outcome, bring complementary skills, and resolve issues quickly, writes YieldStack chief executive Adrian Lee.
Whilst some micro real estate markets are still performing well, most markets across Australia are now in moderate decline.
Whilst the data seems to support a soft landing in the short-to-medium term, funders have begun to tighten their credit policies (particularly in construction funding due to construction cost escalation and declines in project end values), and are offering lower leverage across the board.
The capital stack is somewhat zero sum, so a reduction in senior leverage will require sponsors to tip more equity or alternative capital into projects.
In a slowing market, we almost always see an increase in demand for equity (or equity-like) capital, and mezzanine finance.
These instruments can be a minefield for developers, who fund via less complex senior stretch senior debt facilities via a bank or non-bank lenders.
Below summarises what we believe are key considerations for sponsors looking for an alternative capital partner.
Whether the control mechanisms are governed by a shareholders deed or the terms of a mezzanine facility, a sponsor needs to consider the implications of providing another party significant control over a project.
Most disputes in this space are centred on the level of control or underperformance of agreed obligations of each party.
How much control a finance partner is provided and the obligations of each party should be determined by the balance of experience within the parties.
If the sponsor is relatively inexperienced or has a minimal track record, they will be required to allow capital partners greater influence over the management of the project, and conversely, experienced developers with stellar track records should be able to negotiate a more passive role for capital partners.
The source of return for finance partners are always the same; project profits, interest, fees or a combination of all three.
A transparent engagement will allow sponsors to easily model the true costs of capital across a spectrum of potential outcomes, and this cost should be aligned to the level of project risk.
Be wary of capital that is priced too aggressively and is not commensurate with the risk.
For example, the cost of capital for a DA approved site with a material level of presales is lower on the risk curve and therefore should be less than a pre-DA site.
The investment arrangements across the capital stack can be structured in various ways and will vary greatly from deal to deal.
Sponsors should ensure that the proposed capital structure optimises; timing and cash flow, reduction in senior financing costs, efficiencies in duties and tax and a suitable share of risk between the developer, and the lender-investor.
If the investment is made via subordinated debt, the ability to grant a second ranking mortgage over the property can improve pricing and terms overall vs. no mortgage granted.
The relationship between the subordinated lender and the senior lender needs to be considered as this often impacts the sponsor’s ability to efficiently complete the project.
Capital partnerships work best when partners have aligned motivations, complementary skills, meaningful contributions, and can quickly identify and resolve issues within a framework of trust and transparency.
As an experienced real estate debt and equity investor, we ask ourselves three key questions even before reviewing the project due diligence;
Is the developer passionate about what they do?
Can they be relied upon to do what they say they will?
Are their skills and capability complementary to ours and will we jointly add value to the project?
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