The Impact of Building Industry Reforms on Financing

The Impact of Building Industry Reforms on Financing

The wheels are now in motion for all States and Territories to move forward and implement the recommendations of the Building Confidence Report prepared by Western Sydney University Chancellor Peter Shergold and lawyer Bronwyn Weir (Building Confidence Report). See our February 2019 Newsletter for more detail as to the nature of the recommendations in the Report.

Recent commentary on the state of the building and construction industry in Australia has been damning.

Although the focus of the commentary has been on the size and nature of the problem and the consequences for buyers, residents and owners, an aspect that has received little commentary is how these reforms will impact on developers obtaining finance.

In this edition of our Real Estate Investment Alert, we highlight some of the consequences of the reforms which are likely to impact on the availability of construction/development finance going forward. In particular, we cover:

  • Special purpose vehicles (SPV’s) – will they become a thing of the past?
  • Development industry consolidation
  • The squeeze on profitability
  • Financier’s requirements

SPV’S – WILL THEY BECOME A THING OF THE PAST

It is common practice for developers to establish specific entities to carry out each project. This has a number of benefits to the developer, including asset protection and providing flexibility to borrow money from different lenders for each project.

Lenders also prefer this approach as it quarantines their borrower from claims associated with other projects and insolvency.

Comments have been made as to the disadvantages to buyers of the use of SPV’s by developers. An SPV can be wound up without affecting the business of the developer yet leave the buyers with no ability to recover damages from the developer. Mark Steinert of Stockland was reported as saying this practice “is unacceptable” (AFR 20-21 July 2019).

Also referred to as “phoenixing”, the continued use of this practice is likely to come under the microscope during the consideration of the proposed reforms.

To the extent SPV’s will not be entitled to carry out projects (or their use is otherwise limited, for example to projects where personal or other guarantees are also put in place for the benefit of buyers), this may impact on the willingness of lenders to fund projects.

Without the use of SPV’s, the increased risks of claims against a developer borrower in relation to its other projects and/or insolvency are likely to result in lenders requiring more security and tightening their loan covenants. This will make it difficult for smaller developers to obtain finance or to have more than one project (or a very limited number of projects) active at any one time.

DEVELOPMENT INDUSTRY CONSOLIDATION

The increased cost of carrying out development projects (resulting from the reforms), as well as the above-mentioned difficulty in obtaining finance, may result in consolidation amongst developers.

The benefits of scale in terms of negotiating supplier, contractor and consultant costs, as well as the balance sheets of the larger developers, are likely to result in either mergers or takeovers of the better small to medium developers.

Having a larger balance sheet to leverage off will assist in getting finance.

Such consolidation and the greater market power of larger development companies or groups are also likely to see a number of developers leave the industry.

It will be interesting to see if there are any competition concerns raised as a result of this process.

THE SQUEEZE ON PROFITABILITY

Although it is not clear if the reforms will be limited to high rise residential apartments or extend to a broader range of developments, they will increase the costs of undertaking a development project.

The ongoing difficulty for buyers to obtain finance, as well as the price falls in the apartment market we have recently seen, is likely to make it difficult for a number of developers to achieve satisfactory returns on projects.

Even if they can get finance, buyers will be hesitant to pay higher prices for apartments until they are comfortable the long-term trend in prices is upwards. Until the current oversupply of apartments is exhausted this trend would appear to be some way off.

This squeeze on profits will further add to the consolidation of the development industry.

FINANCIER’S REQUIREMENTS

It is our view that each of the above matters will be taken into account by financiers when considering which developers and projects to back.

Financiers are likely to favour projects which are in excellent locations and where the developer can demonstrate:

  • a strong balance sheet
  • a high level of equity commitment to the project
  • a substantial and successful track record
  • the ability to fund cost overruns from its own funds
  • a willingness to provide guarantees (either personal or otherwise) in relation to the loan and the quality of the work undertaken
  • the availability of other credit support for the loan (not limited to the project) and
    adequate resources to be able to conduct all projects being (or planning to be) undertaken.

Loan to cost ratios and loan to value ratios may be reduced. This combined with an ability to satisfy the above requirements may result in less reliance by financiers on presales in order to provide funding.

Clearly, we are headed into a new world of development and development financing and it will be interesting to see what the development industry and the financing of it will look like in the future.

For tips on how to improve a borrower’s position under finance documents please download my free Top 10 Tips to improve your Australian Property and Development Finance Outcomes – There is much more to it than just numbers available on our Website at www.peterfaludiconsulting.com.au

If you would like to discuss any of the above please feel free to contact us.

Peter Faludi Consulting

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The comments made in this Alert do not constitute the provision of any legal, tax or accounting advice by Peter Faludi Consulting or any Director or employee thereof and therefore you should not rely on this Alert in making any decisions relating to present or future transactions in which you are involved. We strongly recommend that you seek legal, tax and/or accounting advice (as relevant) in relation to the same.

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