Source: Building World (June 2021)
Authors: Jan Topinka, Martin Stančík
The coronavirus pandemic has also had an impact on real estate financing and development. Banks have become more cautious about financing certain types of investments or projects and carefully select sectors and areas. On the other hand, interest rates have dropped, which allows investors to look for new opportunities for appreciating their assets by investments in real estate. To this end, there are various sources available. Besides classic bank loans, these include bonds or crowdfunding as a new trend. The aim of this article is to briefly introduce the individual options, including their advantages and disadvantages
In pandemic times, banks are more cautious and carefully consider the risks of the borrower and the projects to be financed. Although a bank loan is currently relatively cheap and still the first choice for many developers, the penalty for cheap money is less “freedom” on the part of the borrower and some administrative burden in loan administration.
The higher the risk of the project, the stricter the bank’s requirements – this typically involves the requirement to have a certain level of equity, and meeting financial indicators such as DSCR or LTV, and other financial restrictions.
The bank needs to have a high degree of control over the project. Therefore, it is necessary to be prepared for the obligation to provide financial statements (typically on a quarterly basis) and other reporting obligations, a ban on payments to shareholders, a ban on a change of control over the debtor, and other tools that are to ensure that the bank will be well informed and able to demand remedy in the case of any problems or, in extreme cases, early repayment of the loan or the realisation of the collateral.
However, a bank loan need not always be available, especially at the initial stages of development or in the event of the lack of the developer’s equity. Really cheap loans are granted to banks more for finished projects without any development risk. In addition, banks often do not fund projects at all before the construction stage.
Bonds can be used if the bank does not want to or cannot finance a certain part of the development due to risks. Bonds will make it possible to provide funds between the developer’s equity and a bank loan and can thus serve for more efficient financial leverage. They will supplement its own funds with another layer of financing so that the investor can obtain a bank loan.
Typically, bonds are more expensive than bank loans. Interest rates in real estate financing now range from 4 to 7% p.a. and an additional 1 to 3% should be added for distribution costs at the beginning if the bonds are sold through distribution networks.
If a bond issuer wants to offer its bonds publicly for sale (i.e. to more than 150 people outside of qualified investors), it must issue a prospectus, have it approved by the Czech National Bank and publish it on its website. The prospectus is an extensive document containing, among other things, detailed information about the issuer and its business, including the terms of the bond (the terms of issue).
Preparing and approving the prospectus usually takes 2 to 4 months. The Czech National Bank does not assess the quality or solvency of the issuer as the debtor but supervises that the prospectus contains all the information necessary for an investor’s decision to purchase the bonds, including a description of the risks associated with the investment. It is therefore definitely advisable to contact experts who are able to assist in preparing the prospectus.
Defining the business terms of the bonds (such as interest, maturity, interest payments, collateral, early repayment) is entirely up to the issuer, there are almost no restrictions imposed by law. However, the terms need to be set to make the bonds sufficiently attractive to investors and sell well. In practice, the offer usually needs a distributor who is familiar with the market and has access to investors.
Equally important is setting up the financing structure correctly. While the bank usually grants a loan to a project company, the bond reality is more diverse – bonds are directly issued by project companies in rather exceptional cases and for large developments; more often, they are issued at the level of holding or sub-holding companies or via a special purpose vehicle within the group. They then lend the obtained money to the projects, which function as the own funds of the project company that usually obtains a bank loan to finance the project.
Generally, the terms of the bonds are far from as strict as those of bank loans – the reporting obligations are usually minor, financial obligations are lighter or none, collateral is usually smaller in extent, and the issuer has a much greater degree of freedom in the project. On the other hand, changing the terms of the bonds over the course of their life (typically extending their maturity) is relatively difficult, as it requires the approval by a meeting of their holders. In addition, there is a risk that investors who do not accept the change at the meeting may claim early repayment of their bonds.
In our law firm’s experience, crowdfunding, quite a new phenomenon in financing, is becoming increasingly popular, particularly for smaller real estate projects.
Crowdfunding is a way of raising money from a larger number of minor investors who usually contribute a smaller amount to reach the target amount for the person interested in financing. There is a crowdfunding platform between the investor and the developer, which collects money from investors and provides it to the developer.
Compared to bank loans, a loan provided by a crowdfunding platform is not so “strict” in its nature and terms. This is because the platforms are not subject to such strict regulation (see below).
A number of crowdfunding platforms already exist on the market that provide financing for rather smaller projects worth tens of millions of Czech crowns. These platforms are also able to fund projects or stages thereof that are not financed by banks (or for which only partial financing is provided); their terms are usually looser and arranging financing is faster than for bonds and in banks. However, a rule also applies that security must be provided by mortgages over real estate or other project assets. A higher risk is also reflected in the price of the money, and such financing is therefore more expensive than bank loans.
With a correctly set business and legal model, crowdfunding platforms do not currently need to be subject to financial services regulation, which reduces their costs. However, this will change with a new crowdfunding regulation that is to take effect at the end of this year and will impose an obligation on many crowdfunding platforms to obtain a licence from the Czech National Bank: this may curb the currently growing market and make their financing more expensive as well.
A note in conclusion. Other forms of obtaining investments from the general public can be seen on the market, such as loans. However, this practice is illegal, it is considered the operation of an “illegal bank” or collective investment and is subject to heavy penalties by the Czech National Bank. On the contrary, bonds with a prospectus, various types of funds, especially qualified investor funds or the above-mentioned (correctly set-up) crowdfunding are a suitable tool for raising money from the public.
