Understanding the
Intricacies of Real Estate Funding
by Mr. Anuj Puri, JLLR
Real estate
development remains a highly lucrative business line, which is why most
builders retain skin in the game even in the face of strong market headwinds.
However, real estate development also remains a highly capital intensive
business, and among the many new market truths that RERA has brought to the
fore, the fact that only well-capitalized players will endure going forward
stands out.
The 'time-honoured'
practice of raising funds from the market via 'pre-launches' has now become
untenable. In this route, which was always hotly debated but never fully
suppressed, developers raised money from the public by privately marketing
properties in projects that did not yet have the benefit of all regulatory
approvals through informal investor and broker channels. Now, with
RERA in place, this route has become an impossible one for developers.
Fund raising for a
real estate project via other channels is also far from easy these days.
Project finance is now available only if thorough and convincing information
about the development stage of the project in question is available. Financiers
are aware of the fact that the ‘transitional’ phase calls for the highest
amount of funding in the project development cycle. They will now want to know
exactly what the funds will be used for.
Additionally,
financiers will want to be sure of the strength of the developer's management
team and want to have a good understanding of the business plan involved. This
means that the developer will need to project his estimated costs for at least
the first several months and maybe even longer. He will need to draw up a new
plan and cost estimate for every project, since every project has its own
specific funding requirements at various development stages. There is no
general yardstick for start-up costs in a real estate project.
Some projects call for
only minimal funding, while others will entail huge costs in inventory or
equipment.
With RERA's strict guidelines and requirements with regards to
completion timelines now looming larger than life over every real estate
project, developers must ensure that they have sufficient funding to see their
projects to completion.
For a reasonable
estimate of the overall costs, he must include all ‘soft costs’ that will be
incurred during the initial development stage. These will include the cost of
fees for obtaining permits, engineering costs and infrastructure and
construction costs.
Continuous expenses for utilities, inventory, insurance,
etc. must also be included in this estimate. After eliminating all unnecessary
costs and finally arriving at a realistic budget to complete the project, a
developer would have a funding estimate which financiers may accept.
The paper trail a
financier will expect to have access to begins from the word 'go', so even
start-up costs will need to reflect in a worksheet that mentions all possible
cost categories, both one-time and ongoing.
Thereafter, the developer must
maintain regular financial statements to provide the financier with a ready
financial history of the project. This will help the financier to detect
anomalies that could result in losses at any given time.
Obviously, the
challenges for a poorly-financed builder with no real and established financial
discipline to raise formal capital for his project are tremendous.
This, of
course, brings us back to developers who are well-capitalized – that breed of
players who are most likely to prevail in the post-RERA era because they can
raise a sizeable part of the real estate project financing through their own
resources. Thereafter, they have the option of choosing debt and/or equity
financing or a more complex financial instrument structuring.
Debt-based real estate
financing..!
In debt financing, the
developer borrows money from a creditor in exchange for future repayment along
with periodic or regular interest payments based on a pre-defined coupon rate.
The lender has no ownership rights to the developer's business or business
interests, including the project he is financing. However, being a secured,
senior lender will accord him the first right to be paid from project revenues.
Debt financing is a suitable funding avenue when a builder does not wish to
surrender any ownership interests in his business. In debt financing, the
financing cost does not fluctuate and the loan is deductible.
Equity-based real
estate financing..!
If the developer
decides on real estate project financing through equity, he can opt for either
private equity through real estate venture capital or private equity fund, or public
equity. In public equity, he can opt for a listing on the local stock market,
or a listing on a foreign market such as the UK’s AIM. When REITs (real Estate
Investment Trusts) become a reality in India, Grade A commercial space
developers will be able to raise development capital via this route.
In any case, raising
real estate financing from the public markets often turns out to be a costlier
proposition, since it involves investment banking fees and other listing
procedures plus considerably higher levels of transparency and corporate
structure.
Lenders are also
creating structured financial products, especially in debt structuring or
mezzanine financing, to protect their interests. These offer developers another
source of formal funds.
Finally, the way a
developer generates real estate financing must depend on his own strategic
standpoint. Without a doubt, he must research his exact needs extensively
before choosing any particular real estate financing route.
Expert help from
real estate consultants who understand and specialise in project funding often
plays an integral role in helping a developer to determine the exact needs, and
to suggest and enable the most appropriate funding route.
About the author..
Mr. Anuj Puri, Chairman – JLLR (JLL Residential)
For media contact
Arun Chitnis
Media Relations – JLLR
(JLL Residential)
Mobile: +91 9657129999
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