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Financing options for property investment and development Back  
Bryan Higgins examines the broad ranges of financing options available for corporates considering site acquisition, development or the purchase of an investment property.
The simplest division of finance is into equity and debt. Debt finance represents borrowed money that must be repaid and remunerated through interest payments. With equity finance, there are no interest payments and the returns are determined by the success of the project after all other obligations have been discharged. Between pure equity and debt finance is mezzanine finance. Unlike debt finance, mezzanine finance usually attracts an interest charge significantly above senior debt and is also likely to share in the upside, or profits, of the projects.
A summary overview of the characteristics of these three principle types of finance is summarised below:
• Equity
• Mezzanine
• Debt
• Investment
• Quasi-equity debt
• Pure loan
• No interest payments
• Interest payments
• Interest payments
• Profit share
• Some profit share
• No profit share

While these different finance elements vary according to profit shares and interest payments, the most important distinction is the level of security or recourse, each finance element has to the underlying asset.
In terms of ranking senior debt will have first recourse to a project. Mezzanine finance will come next with the second ranking and is often referred to as junior debt. Equity finance will have the last ranking position and can therefore only recover any outstanding amounts after the senior and junior debt providers have been repaid in full. Because of this ranking, the element of risk associated with senior debt is less than that associated with mezzanine, which in turn carries less risk than equity finance. Due to the difference in risk associated with each level of finance, the rate of return required will vary in proportion to the risk with the various types of finance.

Securitisation as a method of raising debt finance while a relatively established concept worldwide is still breaking new ground in the Irish market. Securitisation involves packaging and selling a rental income stream from a number of properties.
An investment bank typically arranges securitisation and the transaction is rated by at least one credit rating agency (Moodys’, Standard and Poors’ or Fitch). The transaction is usually sold into either the syndicated loan or bond markets.
The principle attraction of securitisation as a method of debt finance is that it is usually possible to arrange a higher level of transaction funding than traditional debt finance and it can provide a cheaper source of finance for very large transactions. The main disadvantages of securitisation are the costs, complexity and a longer time period associated with completing a securitisation.

Sources of finance
Debt finance: Traditionally, debt finance has been provided by a bank or building society. Property companies may also raise senior debt through corporate debentures. However, whatever the source of the debt, the fundamental principle is the same: senior debt has first recourse to the property ahead of all other investors and lenders.
With consolidation in the Irish banking market, the number of traditional debt providers has diminished in absolute terms. However, with the acquisition by Bank of Scotland of Equity Bank and more recently ICC, together with the Dutch bank Rabobank of ACC, foreign institutions with significant capital resources are now active in the Irish market which is beneficial in providing competition for financing of medium and larger projects.

Advantages of debt finance
There are numerous advantages in using debt finance for acquiring or holding a property asset. The principle reason is to enhance investment returns through the mechanism of gearing. The introduction of debt, however, reduces the need for equity and providing, the average cost of the debt is less than the annualised total return from the property, the rate of return on the equity will be enhanced.
Along with enhancing property investment returns, with the introduction of debt finance, an investor’s equity can be diversified between other projects. While debt finance increases the specific risk associated with an individual asset, the consequent ability to use the released equity in other projects reduces the overall portfolio risk.
Debt finance can also increase the liquidity of an investment in property by providing a quick and relatively easy way of releasing part of the capital value of the asset. Placing a mortgage on an asset enables the investor to realise value whilst maintaining ownership of the property.

While gearing enhances property returns if the investment provides total returns, which are greater than the cost of debt, the opposite is true when investment returns reduce. In other words, gearing is a double-edged sword.
The more highly geared the investment the greater the sensitivity of the borrower’s returns to the investment’s performance. In other words, the introduction of debt increases the volatility (and therefore the risk) of the equity investment but reduces the overall amount of the equity investment (and therefore the absolute risk).
Gearing can reduce the amount of control an investor has over the management of its investment. The extent of this loss of control will depend upon the particular terms of the debt finance.

Mezzanine finance
Mezzanine finance is available from a wide range of sources; equity providers looking for a lower risk profile than taking a pure equity position, to banks that wish to increase their returns by taking a higher risk position.
The structuring of the mezzanine finance can vary greatly but, because of the higher risk position, the interest cost will be quite a bit higher than that of senior debt. The mezzanine financer in return for taking a quasi equity position may also require percentage share of the profits, depending on the nature and size of the financing in question. The providers of mezzanine finance in the Irish market are very limited and typically, they look for a profit share in addition to a significant margin.

Equity finance
Equity finance can be sourced directly from property investors or private equity funds. The investment returns on equity finance are solely derived from the net income stream from the property and/or the increased or reduced capital value on the sale of the property.
In recent years, the private investor market has grown in Ireland to a point where they are significant providers of equity finance. While a number of boutique finance houses have sprung up in recent years catering for a growing number of wealthy individuals, the stockbrokers, corporate finance houses and private banking arms of the high street banks have been providing a valuable source of equity finance to support property transactions.
However, in recent years, the main focus has been on the UK market with investors prepared to discount the currency risk in the pursuit of anticipated higher returns. This source of finance has typically only been available for investment properties, with a very small proportion of private investor equity available for the true higher risk/higher reward property plays of site acquisition and development.

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