Financing real estate projects: models, sources of capital, and current challenges
Regardless of the type of real estate project, its development costs more money than even the most successful project developer has freely available. Financing is therefore required. What financing options are available, and what are the requirements and consequences of the various financing models? An overview.
What are the biggest challenges in financing real estate projects?
For a long time, it was mainly banks that provided loans and thus enabled the financing of project developments. However, since Basel II at the latest, the requirements for banks to hold capital in line with the risks they take when financing have increased. This minimum capital requirement has been and is being gradually increased. The aim of the rules is to ensure the liquidity of banks. The flip side of the coin, however, is that in order to reduce their risks when granting loans, banks are placing ever higher demands on borrowers, for example, up to 20% equity capital that the project developer must contribute, but also collateral such as pre-letting agreements or the purchase of the project to be developed by an investor (forward deal).
Recently, there has been a change in the interest rate environment—after years in which interest rates were at a historically low level, even for loans, interest rates rose significantly from 2022 onwards. Bank loans became more expensive. At the same time, construction costs rose, throwing earlier calculations out the window, but banks often refuse to increase credit lines.
What can you expect at EXPO REAL in terms of real estate financing?
EXPO REAL is attended not only by a large number of banks, savings banks, and mortgage lenders, but also by insurance companies, pension funds, investment companies, and other financiers. Financing is also an integral part of the EXPO REAL conference program, where experts discuss challenges, trends, and opportunities.
What options are available for financing real estate projects?
Project developers do not always have the equity capital required by banks because the money is tied up in other projects. They are therefore faced with the problem of finding additional and/or other financing options. Options include mezzanine financing, whole loans, joint ventures, crowdfunding, and forward deals.
In order to increase the equity share required by the bank, a project developer can seek mezzanine financing. In mezzanine financing—the term mezzanine is derived from the Italian mezzo, meaning half, and refers to a half or intermediate floor—an investor provides money for a project or company, but does not acquire any rights to influence the project or company in question. Rather, the provider of mezzanine capital participates in the expected profit from the project and/or receives interest. Mezzanine capital is considered a subordinated loan that, in the event of insolvency, is only serviced after debt capital, such as a bank loan. Mezzanine capital is usually classified by banks as equity capital, with the result that debt financing can be increased after mezzanine capital has been raised. Depending on the structure, it may also give a project developer more leeway to increase the bank's credit line should unexpected cost increases arise.
Another option is to find a financing partner for a whole loan—the entire sum above a certain equity share. Especially in the case of very large real estate projects, the partner can be a consortium of banks, which reduces the risk for the individual banks involved, but means that the borrower has only one contact person, the consortium leader.
In addition to traditional syndicated loans, there is also the alternative financing option through institutional investors such as insurance companies, asset managers, or specialized debt funds. The loan amount is divided into a senior loan (priority loan) and a junior loan (subordinated loan), with the junior loan having a higher interest rate due to the higher risk involved. The advantage of this form of financing is that the project developer only has one partner and the processing and coordination times are shorter than with banks.
Particularly in the case of larger projects, the project developer can also enter into a cooperation with at least one other company. In this case, the partners remain autonomous and independent and only work together on the contractually defined subject matter of the joint venture. Since both partners contribute a certain amount of capital, the equity share increases, which in turn makes it easier to obtain corresponding (external) financing.
Crowd investing is a form of swarm financing in which numerous small investors, mostly private individuals, typically invest relatively small amounts of money in real estate projects via an online platform. The return for investors is often very attractive, but this is offset by a higher risk. For the project developer, on the other hand, it means increased effort to address and convince a corresponding crowd (group of people).
One way to realize a larger project is through a so-called forward deal, which involves purchasing a project that the seller (project developer) has yet to build. The buyer benefits from securing the future property at an early stage, while the forward deal has the advantage for the seller of guaranteeing a buyer ( ). There are two variants of a forward deal: forward funding and forward purchase.
Forward funding is also based on a contract between a seller and a buyer that involves the purchase of a property that has not yet been completed. The special feature and, at the same time, the biggest difference to forward purchase is that the financing for the construction of the property lies exclusively with the buyer. In return, ownership of the land is transferred from the seller to the buyer at the initial stage.
In forward funding, the project developer constructs the building and the buyer pays parts of the purchase price depending on the progress of construction. This means that the project developer does not have to finance the project in full.
How do I find capital partners for real estate financing?
Anyone looking for a financing partner and a suitable financing option will find a number of different providers on the Internet. However, it is usually difficult to find out who offers the best terms for each individual case and which of the various financing options make sense. A visit to EXPO REAL can therefore be worthwhile. This is because a large number of potential capital partners are gathered here, with whom you can make direct contact and obtain information.