FUNDING PROPERTY DEVELOPMENT IN AUSTRALIA WHERE TO NOW? PETER FALUDI, founder and director of Peter Faludi Consulting, discusses the way forward for property development funding in Australia following recent changes to the lending environment. There has been a lot of discussion in the last six to 12 months about the difficulties being experienced by both local and foreign property developers in funding projects in Australia. Changes to stamp duty, land taxes, GST, the foreign investment rules, and the appetite of banks to provide property finance have each raised potentially serious obstacles to successfully carrying out a development. The traditional way of funding, using banks where certain presales and other requirements are met, has not been available for some time, resulting in developers having to seek alternative sources of funding. Over the coming years, domestic and foreign developers and other property investors will need to be aware of changes in the lending space, as well as regulatory and governmental policy, in order to continue to fund new projects. These include non-bank lenders, debt capital markets, online lending platforms, and joint ventures. Each of these has their own pros and cons, which will be outlined in this article, and need to be considered carefully. 038 ANZPJ MARCH 2018
RECENT DEVELOPMENTS IN THE AUSTRALIAN PROPERTY FINANCE MARKET The options available for property investors and developers to obtain finance for their Australian acquisitions and projects are constantly changing. Due to both regulatory and market factors, the Australian property finance market has moved from being largely dominated by the major Australian banks to one in which those banks are now limiting their property finance offerings. This has opened up the market to other financiers. 1. Non-bank lenders Although the market has always had some non-bank participants offering both senior and mezzanine (or second ranking) debt, as well as equity for property transactions, up until about 12 months ago the number of such participants were relatively few. The increased number of non-bank lenders now in the market is due not only to the pull-back by the local banks in offering property finance but also the global search by investors for yield/returns. With interest rates continuing to be low in most countries around the world, investors are hungry to tap into the relatively secure and higher returns available from property finance. The pullback by the banks has improved the risk profile of the deals available to non-bank lenders. Traditionally, property investors generally only sought finance from non-bank lenders in respect to the more risky or difficult transactions for which they could not obtain bank finance. The banks general lack of appetite for property finance transactions, particularly for development or constructions loans, has meant that the non-bank lenders are now able to be involved in less risky transactions, thereby making provision of such finance more attractive. As a result, the Australian market now has a wide variety of non-bank lenders looking for good property deals requiring finance. Indeed, based on comments we have received from a number of non-bank lenders, there is currently more money looking for property finance deals than there are borrowers looking for money. This is a 180 degrees turnaround to what the market was like only a few short years ago. Who are the participants in the non-bank lending space? The range of non-bank lenders operating in Australia includes domestic and foreign high net worth individuals, private equity groups, funds established for the purpose of providing property finance, and industry superfunds. The types of loans they make also vary and extend to some or all of senior, stretched senior, mezzanine, and equity finance. The interest rates charged are generally higher than that which would be charged by a bank (if bank finance was available) and vary depending on a number of factors including: The source of the moneys to be lent; The nature of the particular transaction and loan; Whether the borrower has an Australian track record; and The security being offered. Pros and cons of non-bank lenders The benefits often found in dealing with non-bank lenders relative to banks include: They are better able to understand the underlying economics and benefits of the deal relative to some banks, and are therefore easier to deal with; They can often turn around matters in a more timely manner than a traditional bank; and They are keener to participate in the transaction. PROPERTY FINANCE The main disadvantages in dealing with non-banks include: The cost of the loan is higher than bank finance; Some non-banks have onerous covenants and default rights, beyond those generally found in bank documents; and In the case of some less established and/or foreign non-bank lenders, there may be settlement risk, in that they may not have the funds available for each drawdown. As with any finance arrangement, developers should seek advice on the above matters and shop around for the lender that offers not only the best financial outcomes, but also the least onerous terms. 2. Debt Capital Markets There have been a number of developers who have obtained access to debt capital markets where the developer issues bonds to investors to fund projects. Pros and cons of using debt capital markets The benefits often put forward in raising finance using debt capital markets include: The borrower has greater control of the covenants to be included in the financing documentation, which could potentially include a more streamlined process for drawdowns and less onerous default provisions; The borrowing costs may be less than those offered by non-bank lenders; and Depending on the number of bond holders, there may be greater opportunity for the developer to keep control of a project when issues arise. The potential disadvantages associated with using debt capital markets in raising development finance include: 039
Access to this market has traditionally been limited to top tier developers/companies and may not be available to second tier or other developers; The terms desired by the borrower may not be acceptable to the bond holders; The establishment costs associated with transaction may be higher than bank finance or finance from a non-bank lender; Depending on the number and nature of the bond holders, there may be delays in agreeing the terms of the documents relative to the time taken to settle documents with a bank or non-bank lender; Obtaining the consent of the bond holders to matters in the course of the project may take longer than if the developer only had to deal with a bank or non-bank lender; Where the bond holders are located offshore, there may be interest withholding tax or foreign exchange costs for the borrower; and In the case of some less established and/or foreign bond holders, there may be settlement risk, in that they may not have the funds available for each drawdown. 3. Online lending platforms A number of online lending platforms have recently been developed which match borrowers with lenders for particular projects. These platforms can be used for development financing as well as more traditional property finance. Generally, these fundraising platforms are for smaller projects. Such platforms have been used successfully in offshore jurisdictions (such as New Zealand); however they are still relatively new in Australia. Time will tell if these platforms will be significant disruptors in the development finance sector. 4. Joint ventures It is becoming increasingly common in Australia for property developers and investors to undertake projects with one or more other investors, rather than on their own. This can be due to such matters as: the amount required to make the investment is too much for one investor to commit to, or because the vendor is only willing to sell down part of its interest in a project. These co-ownership arrangements can take various forms, with the most common being the use of a unit trust or company, the investors in which are all of the parties who hold or wish to acquire the interest in the property. Other forms include the use of co-ownership and joint venture arrangements. In each case appropriate documentation needs to be put in place to adequately protect all parties interests. Matters to be considered when negotiating such documents include: Funding; Decision making; Dispute resolution; Buy-out rights; Allocation of roles and responsibilities; and The impact on the costs associated with the project when a foreign investor is involved. The form of co-ownership arrangement used will depend on such factors as: the nature of the investors involved, the current ownership arrangements in place in respect to the property, tax consequences or requirements, the nature of the project, and the financing arrangements to be put in place to fund the project. Each of the above factors will need to be considered before determining the most appropriate form of co-ownership arrangement to be used. Failure to consider such matters could adversely affect: The tax consequences to one or more of the parties to the transaction; The ability to raise finance for the project; The ability to make decisions in respect of the project; and The exit strategy to be adopted in certain circumstances. All of these matters may adversely affect the returns made from the project. For example: If a foreign person has an interest in the land or the entity which owns the land, depending on the nature of the project and the State in which it is located, additional stamp duty and/or land tax may need to be paid. If the land on which the development is to be carried out is in the name of only one of the investors, any arrangement entered into to provide the other investors with an interest in the land may have adverse stamp duty consequences. Accordingly, we recommend investors always seek advice as early as possible as to the most appropriate co-ownership arrangement to be entered into and make sure that all relevant headline issues are properly dealt with in the co-ownership documentation. IMPACT OF THE FOREIGN ACQUISITIONS AND TAKEOVERS ACT 1975 (FATA) AND REGULATIONS ON FUNDING The regulation of foreign investment in Australian land, as administered by the Foreign Investments Review Board (FIRB), is increasingly relevant to property developers. This is due to its impact on obtaining funding from foreign joint venture parties and foreign non-bank lenders. Subject to the various thresholds which apply to different types of property (as set out in the Regulations), the restrictions contained in FATA and its regulations extend not only to the acquisition of a direct interest in Australian land, but also interests 040 ANZPJ MARCH 2018
in Australian landowning entities (such as companies and trusts), as would be the case in a joint venture/ co-ownership arrangement. They also restrict foreign lenders from obtaining such interests (e.g. by taking a mortgage or security over such interests) unless they do so in the ordinary course of a moneylending business. For some non-bank lenders this may not be satisfied. If the restrictions apply, FIRB approval is required for the transaction. This involves paying an application fee to FIRB, lodging a detailed application with them, and waiting for their determination, which can be up to, and at times in excess of, 30 days after the payment of the fee. This may be of particular concern where there are tight deadlines to be met. THE FUTURE Based on the increasing focus on non-bank financing options for property developers and investors, in our view the following trends are likely to emerge during the course of 2018: Non-bank lenders While current regulatory and market circumstances continue, the number of non-bank lenders is likely to grow, thereby increasing competition in that market. This may have a positive impact (from the borrowers perspective) on interest rates charged by non-bank lenders. Industry super funds, as well as large offshore institutions and investors, are likely to increase their involvement in this sector, thereby adding further downward pressure on rates and providing a greater choice of lenders for property developers and investors. With the large number of non-bank lenders operating in the market, there is likely to be more segmentation among them resulting in various lenders specialising in different segments of the property market, different size loans, and possibly offering longer term debt. This already exists to some degree. There may even be some M&A activity in relation to such lenders with offshore investors acquiring domestic non-bank lending platforms and consolidation among the participants in the market. Debt capital markets There has long been a push to enhance the Australian domestic corporate bond market. As this push gets stronger, the opportunity for property developers to leverage off that market should increase. This will add further downward pressure on rates available from other sources of development funding. The above trend may also lead to a greater number of retail issues allowing mum and dad investors to participate in providing development funding on projects. Each of the above may improve the ability of second tier developers to access these markets. Online lending platforms As the market recognises the benefits of these platforms and the platforms broaden their product offerings, their use to source development and other property financing will potentially make them a significant disruptor in the property finance industry. Joint ventures Increasing property prices and difficulties in obtaining the full amount of debt finance needed for a project is likely to drive the continued use of joint ventures and other co-ownership arrangements in property development and investment transactions. Increasing appetite by foreign investors to have exposure to Australian property will result in a greater number of joint venture arrangements involving foreign investors. This brings with it a number of challenges which need to be carefully considered. These include: 041
The impact of the Foreign Acquisitions and Takeovers Act 1975, its regulations as well as the Foreign Investment Review Board Guidance Notes on the timing of the project; The stamp duty and land taxes payable on the project; The level of input from the foreign investor in the project and decision making; and The structure of the joint venture arrangement and its tax consequences to the investors involved. CONCLUSION: KNOWLEDGE IS KEY There is no doubt that property development in Australia has become increasingly complicated over the last 12 to 18 months. Changes to stamp duty, land taxes, GST, the foreign investment rules, and the appetite of banks to provide property finance have each raised potentially serious obstacles to successfully carrying out a development. Nonetheless, economic factors, both in Australia and overseas, continue to make Australia a prime destination for people to live and invest in. Consequently, development will continue, but in a different environment. Both domestic and foreign developers and other property investors will need to be smarter and more alert to the changes that have occurred and will continue to occur. They will need to obtain appropriate advice early and ensure they are on top of relevant issues (both regulatory and financial) before committing to a project. Once they have the knowledge they need to facilitate the transaction, the project should be able to proceed with minimal unexpected disruptions. ABOUT PETER FALUDI Peter Faludi is the founder and director of Peter Faludi Consulting - Property Investment and Financing Advisory (PFC). PFC focusses on: Minimising the cost and time associated with implementing a property investment or development transaction; and Maximising the ability of investors to protect their interests when negotiating the initial documentation with the other parties to the transaction. Peter has more than 30 years of legal and transactional experience in assisting developers and investors to understand the legal, documentation and structuring issues associated with financing, joint ventures, development management, FIRB approval and other issues relevant to investment in, and development of, property in Australia. He also has developed relationships with a broad range of advisers as well as non-bank lenders to further facilitate such transactions. www.peterfaludiconsulting.com.au 042 ANZPJ MARCH 2018