UNDERSTANDING CONSTRUCTION FINANCING

For some years now the real estate industry in Kenya has been growing in leaps and bounds. During this time some investors have made astronomical profits turning some into overnight millionaires. As a result of this most people have a great desire to enter into this industry that seems to have magic for turning people into millionaires.

Real estate industry has a myriad of challenges which need to be overcome before one can start making the millions. One of the biggest challenge that has to be overcome by most developers and investors in this industry is ‘how to fund their real estate projects’. Quite a number of people I have met who would love to become real estate developers always don’t have sufficient resources to fund their real estate developments to completion.

This is a unique characteristics in the industry as even government bodies, big corporations, large and small companies and individuals are faced with this same problem ‘lack of enough or sufficient resources to completely fund their development projects.

Does this therefore mean that one cannot get into the real estate with the little they have? Not at all as there are several avenues to fund real estate project that has a return on investment. For a real estate development to attract funding one has to come up with a business plan or what is commonly referred to as a financial proposal. This business plan has to show that the investment is economically viable.

I will seek to look at the various avenues that are there in the real estate and financial sectors to fund a real estate development. Due to the high rate of return in the real estate developments, a lot of financial institutions and individuals are always willing to be involved in the funding of some of these projects. It is important to note that most of the local banks have subsidiary companies that are specifically dealing with construction funding.

There are several ways and places one can explore while planning to get funding for a real estate project;

-          Personal saving

-          Financial institutions

-          Pre-sales/Off-plan sales

-          Joint Venture

-          Contractor financed

-          Offshore funding

Personal saving/Owner funding

This applies where a developer has enough money to run the project through to completion. This is a very rare scenario and mostly happens to projects of smaller scale that do not require heavy capital outlay and also common among developers who been in the industry for a longer time. It is important for the developer to come up with a development budget for the project so as to be certain that he/she has enough capital to complete the project. Once he has come up with a budget it is also important to develop a cashflow which allocates the finances to the different activities and phases of the project. This method has no huge expenses in terms of cost of finances and is therefore very profitable.

Financial Institutions

Banks for a very long time have been the most common sources of construction loans but in recent past several other financial institutions have entered the market. This has made it easier for developers to get finances for their developments.

Financial institutions offer real estate development finances in two forms;

1.      Construction loan

With a construction loan, you are asking the bank to estimate the value of something that does not yet exist and then lend you money for it. A lot can happen during the construction process from the expected construction delays and cost overruns to the unexpected like a change in your employment situation or your builder going out of business. The risk to the bank is much greater, so it exercises greater caution in loan decisions. The loan is supposed to be paid immediately the development is complete.

For a construction loan to be granted, the real estate development projections have to be realistic and able to show that it is profitable. The developer also has to show how he will be able to repay pack the loan.

A construction loan is really a reimbursement process. The bank does not advance construction funds; it will only pay for construction items that are complete. Each month you must submit a draw request along with supporting documentation to prove that building is progressing. The bank reviews the documentation; the bank relies heavily on the team of consultants documents certifying a payment but can also do their independent confirmations.

Most banks and financial institutions do not offer full financing to a particular project. They require the developer to commit a certain percentage to the total cost. Most of them give 70% of total construction cost. The 70% they give is only available after you have fully exhausted the 30% a developer is supposed to contribute. Interest for the loan give is normally supposed to start immediately the loan is awarded but if one is not able to start paying immediately one can apply for a moratorium. Basically a moratorium on loan repayments is a loan repayment holiday. You are not required to make loan repayments or pay dues/fees for non-payment for a required period. Usually for financial hardship members/clients and needs to be organised and approved with your loan supplier.

2.      Construction Mortgage

A loan borrowed to finance the construction of a real estate development and typically only interest is paid during the construction period. Once the construction is over, the loan amount becomes due and it becomes a normal mortgage. The money is advanced incrementally during construction, as construction progresses. The advantage of such plans is that you have to apply only once and you will have only one loan closing.

PRE-SALES/OFF-PLAN SALES

This method of financing is common in real estate developments that are fast moving commonly referred to as ‘hot cake’. In this method the developer seeks to sell the property before actual construction starts on site. The developer normally gives incentives to early buyers who buy the property off-plans by giving a discount from the actual cost. The developer can say decide to sell the property at 15% off the cost it would have cost if buying when complete. Through this way the developer gets money in advance which uses to finance the construction.

JOINT VENTURE (JV)

A Joint Venture is a partnership in which people decide to pull resources together. In most cases one person has the land while the other person has money.

How does the JV work?

A Joint Venture works whereby a land owner does not have the requisite funding enabling him obtain financing from a bank. In most cases, banks require that the land owner fund approximately 30% of the total cost of the project including land and consultancy fees.

Where the cost of land is less than 30% of the total costs, banks require that the land owner top up the difference either using cash or construction input till foundation stage. This top up is what lacks to most land owners. Joint Venture partners come in to assist the land owner reach the required bank minimum of 30% contribution by the land owner.

Another way a Joint Venture works, the Land owner contributes the land as part of his/her contribution, then the Financier contributes finances for construction. The profits are then split on a pre-agreed ratio with the land owner usually getting over 50% of the net profits.

In the joint venture agreement a Special Purpose Vehicle (SPV) has to be formed. An SPV is a company owned jointly by the financier and the Land Owner. The land ownership is now transferred to the SPV.

CONTRACTOR FINANCED

This is another form of Joint Venture but in this case the joint venture partner is the contractor who will be given the work of construction. The developer enters into an arrangement with the contractor such that the contractor agrees to do the works and receive payment at the end of the project. Just like a Joint Venture a Special Purpose Vehicle is created.

QS Gachagua Ngunjiri
0726432769
gachaguagreat@gmail.com
@Gachaguas