S A National Treasury

Cities Support Programme

Prof Francois Viruly

3-5th November 2014

How to Participate : Real Estate Investments can be Made from a wide range of starting points

Public Private

Equity

Debt

Public

Equity

Private

Equity

Public

Debt Private

Debt

Property Finance and The Economy

Share Capital

Loans

Government

Fixed Assets

Operating Cost

Working Capital

Cash

Understanding the Use of Funding V = D + E

Mortgage

Lender

Sources Types

Building society Short-term

Banks Long-term

Insurance

Individual Real Estate

Investment

1. Individual

2. Company

3. Partnership

4. PUT

5. Syndications

6. Share block

Government

1. Central

2. Regional

3. Local

Tenant

1. Residential

2. Commercial

3. Industrial

4. Special purpose

5. Other

Real Estate

Investment

Promissory note Restriction on lenders

Mortgage laws

Property rights

Mortgage

document

Lease document

Debt

service

Cash flow

Restrictions on use:

taxation, eminent

domain, police power

Leasehold Use of property

Income taxation

Landlord / tenant laws

Restriction on User

Income taxation

Participants in the Real Estate Investment Process

Financing the Project : Equity and Debt

EQUITY DEVELOPER

DEBT MEZZANINE FINANCIER

DEBT BANK

- limit the equity -more costly than mortgage bond

-optimise returns

- flexible lending - plays role as developer/lender

-reduce risk

- low financial risk -limit exposure

- reduce indifference -assessment of project

-management

The Financial System

SAVINGS

Banks Unit Trusts Pension Funds

Property Unit Trusts Property Companies

PROPERTY SECTOR

Other Investor

The Market Costs

Value Components

Rentals

Cap/Discount Rates

Vacancies Escalations

Land Prices

Building Costs

Interest Rates

The Project Physical

Legal

Society

Land

Costs

Total Capital Costs

Escalated

Construction

Costs

Professional

Fees

Finance

Costs

Marketing

Costs

Other

Costs

Total Capital Costs

Residual Land Value

Area Rate Costs

Building

Building costs 8,000.00 5,200.00 41,600,000.00

Parking 300.00 3,000.00 900,000.00

Design fee 0.14 5,950,000.00

Plan approval 8,000.00

Service connection 25,000.00

Geotechnical survey 7,000.00

Total 48,490,000.00

Commission

Commission 240,000.00

Development concept fee 100,000.00

Total 340,000.00

Contingency 0.06 2,909,400.000

Developer 15% GDV ( i.e G28) 0.15 13,147,826.09

Total Development Cost Excluding land and financing 64,887,226.09

Interest 6 month development period

On Progress 0.55 0.12 1,600,170.00

Total Development Fee

(Incl Interest) 66,487,396.09

Capital Value

Offices 7500 100 750,000.00 monthly 9,000,000.00

Parking bays 300 300 90,000.00 monthly 1,080,000.00

Cap rate 11.50% 87,652,173.91

Land Value

Residual land value 21,164,777.83

Rates 70,000.00

Rezoning costs 20,000.00

Financing - 6 months 12% 1,275,286.67

Land price 19,799,491.16

• Merchant Banks

• Insurance Companies

• Listed Funds

• Government institutions ( IDC )

• Private Sector

• Corporate Bonds

The Sources of Finance

The Growth of the SA REIT Sector

• Commercial mortgages

• Development Loan

• Equity participation

• Joint Ventures

• Mezzanine Finance

• Sale and Lease Back

Types of Financing

Requirements for Development Finance 1) Financials of Developers · Who is the borrowing entity · Shareholders % interest in borrowing entity · Company’s latest audited financials and management accounts · All shareholders financial statements / assets and liabilities · Company’s organogram – how the company is structured 2) Property Details · Sales agreement and title deed · Or Land Availability Agreement 3) Project Details · Site description, · Area analysis including potential demand. · Detail of project – that is ho w many houses, is it top structure and services 4) Developers and Contract History and Experience Details · Developers – experience and CV’s · Contractors details and experience and CV’s 5) Required Financing from the Bank · Amount of finance required and period o f loan; · Amount of equity injected by the Client prior to any finance being made

available

1) Cash flows

Cash flows of the project

2) Loan Covenants

Equity 20% of total development cost

LTC 80%

3) Security

First Ranked Continuous Covering Mortgage Bond

Cession of Income

Sureties to an agreed level from acceptable counterparties

Cost and interest overrun sureties and undertakings

Clause allowing the bank to step into the development:

Variables of Loan Terms to Negotiate

• Loan amount

• Loan Term

• Contract interest rates

• Up from fees

• Recourse – non recourse

• Collateral

• Lender participation

• Structure the lending

Lending Criteria

• Character – Trading History of the borrower

• Cash Stake – How much equity is going into the transaction

• Capability – Capability to service the loan

– Financial position

• Collateral – What is being offered

– Value

– Saleability

– Exposure to the value

Categories of Finance

• Debt or equity Look at cost Structural Issues Financial Risk

• Project finance or corporate finance • Secured or unsecured • Fixed rate or variable rate • Long term or short term

Repayment Structures

• Bullet Repayment – interest only

– Capital lump sum at the end

– Used By developers

• Capital and interest – Most Common Structure

• Capital Holiday – interest only for a period

– If rental is not sufficient to repay interest in the initial period

• Deferred Interest – Interest is rolled over

– If no income exists – Developer

Development Draws

MONTH DRAW INTEREST TOTAL DRAW

PAYMENTS PRINCIPAL

ENDING BALANCE

0 1,019,200 0 0 0 1,019,200

1 655,200 10,192 665,392 0 1,684,592

2 655,200 16,846 672,046 0 2,356,638

3 655,200 23,566 678,766 0 3,035,404

4 218,400 30,354 248,754 78,430 3,205,728

5 218,400 32,057 250,457 78,430 3,377,755

… 0

10 0 31,803 31,803 158,014 3,954,108

11 0 30,541 30,541 158,014 2,926,635

12 0 29,266 29,266 158,014 2,797,887

The Development Process and Cash Flows

OPTION PERIOD

- Secure land

-Feasibility Period

-Site negotiation

-Design Framework

DEVELOPMENT PERIOD

-Developing contracting period

-Coordinate with contractors

SALES/LEASING PERIOD

-Implement maintenance programme

-let/sell space

-facility/proposed management

-asset management

NEGATIVE

CASH FLOW

NEGATIVE

CASH FLOW

Construction Draw

“s” curve

REPAYMENT

OF LOAN

POSITIVE

CASH FLOW

• Pricing

• Genuine

• Speculative

• Adverse publicity

• Lobbying

• Sensitive areas

• Volatile markets

• Rising markets

• Margin squeeze

• Controlled environment

• Does it make sense?

• Is it pioneering?

• Does it have long-term durability

• Sector of the market ?

• Track record

• Financial strength

• Depth of management

• Professional team

• Project manager

• Contractor

• On-time & within budget

• Volatile environment

• Exchange rates

• Long lead times

• Action groups

• Elections • Security

• Tax needs

• Entity

• Ring fencing

• KISS

• Impact of delays

• Phasing

• Attorneys

The Market

RISK

Conceptual

Environmental

Interest

Rates

Conveyancing Structuring

Political

Delivery

Developer

Conveyancing

Compliance

• Certificate of identity of the property

• Contractor’s all risk insurance

• Waiver of builder’s lien

• Proof of borrowers contribution

• Approved township layout

• Approved Site development plan

• Approved Building Plans

• Signed service agreement from Council

Compliance ( II)

• Certificate to commence

• Professional indemnities

• Occupation certificate

• Progress certificates

• Practical / Final completion certificate

• Pre-sales

• Valuations

• Leases

Commercial Mortgage Underwriting

• Negotiations happen to reflect the strength of the client.

• “ to make default a rare event”.

• There will always be some level of risk.

• The focus is on:

– Borrowers

– Properties (probably the most important)

Participation Mortgages

• Lender plays a role (equity).

• Some equity participants.

• Return higher than base contract interest rate.

• Reduce risk.

• Often leads to a lower interest rate.

• Participation in :

– Operating income (above a threshold)

– Reversion (fraction)

Direct & Indirect Investment

• Direct Investment – Advantages

• Low Risk relative to equities

• Diversification

• Hedge against Inflation

– Disadvantages • Illiquid

• Management intensive

• Difficult to grow a portfolio

Development and Investment Lending

• Speculative Development

– Borrower will need to be very Strong

– Exceptionally Profitable Scheme

– High Level of Equity

– Prove Demand for the scheme

• Pre let/sold Development

– Easier

– Who is the tenant

ERF 186 – Roggebaai • Zoned “ Government “ • Preserve Space for Public use

Ten Golden Rules for Financing

Never use own money for a development ; strive for full outside funding

Never give a personal guarantee

Always role up interest during the development period

Keep as much of the equity as possible

Restrict to the currency of the country

Avoid 50% relations

Watch tax “crossing the Rubicon”

The bigger the project; the more problems one can expect

Be careful in structuring finance through SPV’S etc.

Make sure that the funding is in place from the outset

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