Role of traditional banks, global capital and government funding
Traditional banks play a vital role in providing construction loans, while global capital sources, such as mezzanine finance and equity players, are increasingly active in property lending.
Developers often create special purpose vehicles (SPVs) to acquire project land and manage development projects. These SPVs serve as the borrowing vehicles, with financiers typically securing their loans through first-ranking claims on all SPV assets, as well as a first-ranking mortgage on the underlying property asset. In some cases, developers may establish a second SPV to manage contracts with builders and architects, allowing them to handle sales and leasing as well. In these cases, the financier's security extends to the assets of both SPVs.
Entities are usually set up as proprietary limited companies or trusts. Exploring alternative structures can provide benefits, for example, charities can access tax advantages, such as stamp duty concessions, that lower initial project costs. Although charities are often set up as companies limited by guarantee (meaning they can’t issue shares to raise equity), they can issue loan notes that allow noteholders to assume a position similar to shareholders in proprietary companies. These loan notes are subordinated to a senior financier, meaning they will be repaid only after the senior financier has been repaid in full.
To tackle the issue of housing affordability, private investors and developers are partnering with community housing providers (CHPs) and not-for-profit organisations. These collaborations may facilitate access to funding from Housing Australia and various state government programs, such as the Affordable Housing Investment Partnerships in Victoria. These funding sources typically offer lower interest loans for longer terms than what private lenders provide, ensuring that projects generate sufficient returns to attract further private investment.
Alternative financing options across the life of a project
Financing a housing project is generally divided into three key phases:
Land Acquisition: Securing financing for land purchase.
Construction: Funding the development phase.
Operational Phase: Financing ongoing operational costs as units are sold or leased.
These stages are typically covered by one facility agreement, which has separate facilities for each phase. The operational facility (phase 3 above) refinances the earlier stages and allocates funds for ongoing operating costs. As projects near completion and the project’s risk profile is reduced, developers frequently reassess their financing options to secure better terms.
This stage is also an excellent opportunity for public financiers like Housing Australia to collaborate with private developers. Since completed projects carry less risk, lenders are often more open to offering longer-term loans with steadier returns, especially beneficial for build-to-rent developments that rely on ongoing rental income.
Another critical aspect for build-to-rent projects is securing adequate equity funding. For build-to-sale projects, lenders usually require a specific number of pre-sales before releasing funds, ensuring market acceptance of the housing units. If investors cannot commit all their equity upfront, the borrower (in a fund or trust structure) may seek a subscription line facility (particularly as a form of bridging finance), allowing lenders to provide loans secured by future equity commitments of the investors. The availability of this structure depends on having reliable, credit-worthy investors.
Streamlining documentation and financial control
The security structure for construction financing in Australia is generally standardised, but facility agreements and related documents often remain customised. While the Asia Pacific Loan Market Association has recently developed a template for real estate transactions, there is still no unified approach for construction financing. Financiers often have standard covenants that vary in strictness depending on the sponsor's strength and the project's feasibility. Developers are particularly concerned about restrictions on project time and cost variations, especially given recent supply chain disruptions.
There is also a need for greater consistency in how financiers handle side deeds with builders. These documents are vital for lenders as they provide step-in rights if a borrower defaults, which could jeopardize project completion. A consistent approach to key clauses would streamline negotiations and help manage stakeholder expectations.
Another important issue is the control that financiers require over project bank accounts. During construction, lenders typically require a blocked account for sponsor contributions and mandatory payments, along with an unblocked account for daily operational costs. Once a project is operational, borrowers need a proceeds account for income distribution as specified in the finance documents (for example, rental proceeds). However, due to operational constraints and/or policy requirements, increasingly it is becoming less common for account banks to enter into such account control agreements unless the financier is also part of the senior lending arrangements. Financiers have therefore been asked to get comfortable without that level of perfected security over bank accounts or negotiate other terms to mitigate any such risks.
Ultimately financing is just one important piece of a larger puzzle to relieve the current pressure on the affordable housing market in Australia. Solutions will need to involve a collaboration between optimal transaction structure, support of traditional lenders whilst incentivising institutional capital investment, government assistance (at both federal and state levels either via subsidised funding, grants or tax concessions) and an efficient and consistent regulatory framework for local government and development approvals.