Q&A with Mark Hayes - Director, Right Angle Group
Questions from Sebastian Muscolino - SPS Group
Q: What have been the most notable changes that you've seen in debt markets for
residential development funding over the past few years?
A: The inbuilt structural restriction of credit availability in the post GFC world has
produced, and will continue to produce, significant impacts, in our housing markets. In the
post GFC world, Banks are only permitted to hold a certain percentage of their loan book in
residential development mortgages. A 'cap' so to speak. When the 'cap' is approaching its
limit funding slows considerably until those funds advanced are repaid. The issue is that
the first driver of the demand and supply dynamics in our housing markets is heavily determined
by preset Credit Portfolio Preferences that don't necessarily relate to the true underlying level
of demand / need and reasonable supply. The ongoing consequence of this is that we have to deal
with shorter capital cycles and the inevitable lower transactional volume and increased volatility
that comes with this to our markets.
Q: With the recent tightening of debt from the majors, is syndicated equity becoming
more important in funding development projects?
A: Absolutely. As great as it sounds it is not as easy as you are talking about - and not just
the challenges of pooling financial resources, but also, the challenges of operational resources
and trying to figure out roles and responsibilities. And this is about establishing 'right fits'
which takes time to establish comfort and trust. I think syndicated debt is going to be a
developing space in the market moving forward - more so in the $15M to $50M space for SME
Residential Development Borrowers.
Q: In your experience, what are the main reasons for not being able to source development
funding, and how can this process be better managed?
A: The biggest issue over the last 10 years has been insufficient equity from the Developer to
put toward the development. For SME Developers, the general rule of thumb in the current market is
that they should be able to fund the acquisition and consultants preliminaries for the Development
Approval before they commence a Development Funding process.
Q: Many financiers talk about 'de-risking' a project before funding it ... can
A: 'De-risking' is what has been done to cover off on Delivery Risk / Contractor Risk and also
on Sales Risk/ Repayment Risk. In addressing Delivery Risk / Contractor Risk, Banks typically require
a Fixed Price Contract from a 3rd Party Builder, and increasingly, are requiring a greater degree of
financial disclosure on the Contractor prior to approving the loan. When it comes to addressing Sales
Risk / Repayment Risk, these concerns are usually allayed with a level of pre-sales that can be properly
validated in terms of the buyers capacity to complete their purchase.
Q: How much influence does developer experience have on the funder's decision-making
process and can this be partly outsourced to, say an external DM?
A: In a more credit constrained environment we are in, and will continue to be in, Developer
experience is key. I don't believe the answer or value add of Developer Management assistance
would work for an Owner / Principal that is looking to develop for the first time. If anything,
I see more opportunity and need for existing SME Residential Development businesses to engage
external Project Management or Development Management persons on a 'locum' basis to give them the
additional operational muscle they need on Projects ( especially if that business is trying to
manage multiple Projects ) to keep them moving properly. The reality is we live in a world of
increasing compliance, more validation and a reluctance to make decisions - or at least an increasing
slowness and caution in making decisions at Council level for Development Approvals, and at Funding
level for Project Delivery. As a consequence, many SME Residential Development businesses need
additional operational muscle in process driving these components so as to cut down the time impost
in delivery as much as possible.
Q: With the gradual fall in the cost of funds in recent years and a tightening of
investment yields, has the expectation of developers and/or funders been realigned, or has there
been no movement in relation to ROI?
A: I will answer this in the context of expected returns for Residential Development Projects
where the continuing 'gold standard' has been to show a 20% Return on Total Development Cost.
Q: What types of changes, tailwinds and headwinds do you see in the foreseeable
future in the development funding space?
A: After a very flat and wound back 'redeeming' Credit Market between the back half of
2017 to 2019 - after what was filled up in Credit Supply directed to the Residential Development
market between 2014 to 2016, we were starting to see some upswing in Credit desire to do business
before COVID hit. We were already an under produced market where supply in new stock, and, retail
mortgage offering had been significantly curtailed over the last 2 to 3 years in particular -
mainly as a result of a lot of political jousting between APRA and the Banks that you can make
a case has been more excessive than it needed to be. This is why we were seeing 2.50% Interest
Rates and 5.00% to 6.00% gross yields on residential property investment through most of 2019.
Now through 2020, but more importantly through 2021 and 2022 when new stock should have been
maturing to market (that commenced in 2020 and 2021) - we will see additional significant
restriction of proper supply coming to market as a result of a significant drop in credit desire
to do business at this time. Australia has had a 'modest and measured' immigration market for
several years - and so the immediate drop off in numbers will be a short term factor. But there
is a reasonable argument that we were not meeting true needs prior to COVID where there were
genuine signs that we may have seen a mini-bubble through 2020 to 2022. But now with what we are
faced with as a result of COVID we perhaps have only deferred the next bubble until 2022 to 2025.
To add to the above idea, if and when a COVID vaccine is delivered, and, if there is a political
will to do so within Australia, conceivably, we could be in a longer term ascending / growth
market where our population could increase of its current base by at least 50% over the next
10 to 15 years. It would not be unreasonable to assume that in the post COVID World, Australia
and New Zealand are seen as high demand immigration destinations, and further, it is also not
unreasonable to expect that immigration demand may hit the same relative levels as to what it
did through the 'big nation building years' of the 1950's /1960's. If this does happen in the
next 2 years or so we could be on the cusp of a genuine economic boom - with a significant
housing boom that accompanies that and forces all the old paradigms surrounding credit supply
generally to be re-thought. And especially as it relates to Residential Development Funding Supply.
Q: What is the medium-term outlook for development funding - interest rates, debt
cover expectations, overall banking appetite, and will there be a bias towards certain
types of project?
A: Transaction volumes will remain low as all Credit Suppliers remain cautious in the
current market. Interest Rates will remain where they are at least for the next 2 to 3 years,
although, with lower transaction volumes be prepared to see some increase in margin and fees
to make up for some historically low transaction volumes. Banks will stick to the letter with
regard to their policy on presales but I am already starting to see evidence where they are
lowering Loan to Valuation Ratios which has the impact of triggering a greater degree of
Borrower Equity to be put into projects.
Private and Alternate Funds will also see this as an opportunity two ways:
1. To increase their quality of credit ( IE: who they lend their money to )
2. To increase their margins in pricing
Their offering won't be too far from where the Banks are at , but , their
continuing advantage will likely be slightly less presale coverage compared to
the Banks - and then possibly some marginal gearing benefit in slightly increased
Loan to Valuation Ratios.
In terms of projects that may see preference over other I would suggest:
1. The new housing / house and land market in the $450,000 to $650,000 bracket
2. Smaller yield Townhouse and Apartment Product ( say under 20ish ) that is geared
toward the middle suburban $500,000 to $800,000 range and more toward Owner Occupier
3. Larger, one per floor, or one of two per floor, type product in a mid $1,000,000
to $3,000,000 Baby Boomer Owner Occupier Market