Declining sales in the primary housing market (for new homes) make it more difficult for developers to routinely secure a bridge loan to buy a land plot and design a project. Anton Nikoliers, land sales and development projects director at Nikoliers, explains how to raise funding to buy a plot of land for development project.
Since 2019, when Russian developers had to switch onto project finance model, the industry has undergone a big reshuffle, forcing some players to quit the play field, triggering a market consolidation, and clearing the way for large-scale regional and nationwide development corporations. The introduction of escrow accounts helped to solve a key issue for the shared equity housing market – it made the development funding process as transparent and predictable as possible via a distribution of risks among all the participants. Once developers got access to secure and predictable funding from banks, they have become less dependent on inflow of money from new buyers.
However, the new model have not been able to solve all the problems and cover all the requirements of development companies. For a majority of developers the key problem is not to secure a loan to finance construction works, but to get the money to finance land plot acquisition, initial planning and permits proceedings, as well as expert appraisals. The lack of initial funding was one of the key reasons, why smaller developers were squeezed out oof business.
The easiest way for developer to launch a project is to find a land plot with approved planning design and building permits, in this case the company can immediately apply for project financing, pay off for the land plot and begin the construction works. We see that demand for such land plots has been growing over the last year, especially among regional developers. However, the supply of such plots in St. Petersburg has been nearly used up, while demand for them remains persistently high.
The problem of having to get a project off the ground with a “bare” land plot without initial documentation, or with approved design only, can be solved via securing a bridge loan. Such loans typically have pretty high interest rates and tend to be taken by developers for a short term – to cover the costs until the proper project funding is available. In 2020-2021, when Russia’s central bank was lowering its policy rate and the market was growing, developers were quite willing to use bridge loans to buy land plots, and then spend a year or two to prepare the required documentation while continuing to pay interest on the bridge loan.
In 2022, the task of obtaining a bridge loan became much more complicated. As new homes sales went down, developers funding schemes were increasingly coming under more intense scrutiny from the banks while the costs of borrowing were rising. Lenders began to pay much more attention to loan life coverage (LLCR )and loan to value (LTV) ratios, the project’s margins and various other factors. In addition, banks tend to demand a larger initial contribution from the developer versus the sum of the bridge loan: in the past the bank might cover up to 90-100% of the developer’s front-end costs, now the lender may require a contribution from the borrower of up to 40%. As a result, now bridge loans are typically taken out to finance acquisition of only the most lucrative plots in unique locations, or cover just a part of the land plot acquisition costs. And development companies often tend to prefer some alternative funding schemes for less conspicuous projects.
One of the most widely used models is to buy a land plot using an instalment payment scheme. Land plot deals with a 100% down payment for a “bare” asset are becoming increasingly rare, as well as acquisitions of such plots financed via bridge loans. An instalment plan sometimes becomes the only possible way to sell off a less attractive and relatively illiquid land asset. Payment dates within such plans are often linked to key stages of the project, such as obtaining the territorial development plan or the building permits, or even to the opening of escrow account after commissioning.
Some land plot owners are too concerned about inflation risks and prefer the brick and mortar assets over cash. Such schemes, for instance, are used by Samolet Group – this developer enters agreements under which land owners receive apartments as a payment in kind and subsequently commission the parter to sell these assets. Most often the landlord also has to wait for the completion of the project and opening of escrow accounts before he is enabled to sell the assets received as a payment in kind.
Since the introduction of mandatory escrow accounts, bond funding has become increasingly popular among developers. While this funding may be more expensive for development companies than bank loans, raising funds on the debt market is a more flexible instrument allowing to get money for any business requirements faster. Nearly all major developers in Russia have come resort to bond issuance now and then. Mosct notable recent examples include GloraX, which in March 2023 announced plans to place one more issue of commercial paper, and Setl Group, which has increased its bond issuance to a total of 5.5 billion roubles.
Another instrument widely used by development companies is raising supplementary project financing via closed-end mutual funds. Closed-end funds can be used to lighten the company’s debt burden and allow to re-invest income more easily as such funds are not legal entities and don’t have to pay corporate income tax. This option enables developers to use closed-end fund’s money to finance land acquisition and the process of obtaining permits, while the fund’s dividends are paid out after the property is commissioned and the escrow accounts are opened. Samolet, PIK, FSK, MR Group and some other major developers an even second-tier companies have already began to experiment with closed-end fund schemes to diversify project financing, optimise tax burdens and solve some other business issues.
The two mechanisms to obtain initial funds to get the project off the ground – bank loans and alternative financing – are evolving simultaneously, and their respective popularity among the market player depends directly on market conditions and the policy rate. If the central bank lowers its policy rate, bridge loans will become more affordable; if consumer demand grows, it will make banks to ease their requirements for loan approvals; in this case developers will be more willing to borrow from the banks.
However, according to the Russian central bank’s projections, “the key rate is more likely to be raised rather than cut this year”. Currently, developers continue to seek alternative options to cover initial project costs. Those mechanisms, which used to be quite rare some four-five years ago, when the shared equity model was very popular and widely used, are gaining popularity in 2023. Closed-end funds, for instance, may become a viable alternative to both bridge loans and the project financing model itself.
