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6.3 FINANCING OF A REAL ESTATE DEVELOPMENT PROJECT

6.3.1 Description of the Residential Development Project

The loan is designed to finance construction costs for a residential development project[1] and will be repaid following the sales of the individual properties (apartments) as they are concluded, without any provision for a transfer of the loan. Expected timing and cash flows are shown in Figure 6.17.

The borrower will purchase the land with its own capital (fully equity financed) and request a bank loan equal to cover the full amount of the construction costs (LTC 100% on capital expenditure only). It is assumed that 25% of the price of the apartments will be received upon signature of the preliminary sale agreements, and the balance upon conclusion of the sale (final deed).

6.3.2 Term Sheet for the Development Project Loan

PROPERTY PROVIDED AS SECURITY

Property located in ..., under construction, in respect of which construction permit no. ... of... has been issued.

AMOUNT AND PURPOSE OF THE LOAN

In order to cover the costs of building the property provided as security, and ensuring the issue of sureties as guarantee for any advance payments received from end buyers of the properties provided as security, the Bank will structure a loan including the following facilities.

Principal facility

The lowest of the following amounts will be loaned:

1. €52,000,000;

2. 100% of the construction cost for the properties (excluding the cost of the land), as determined by an independent appraiser appointed by the Bank;

3. 60% of the value of the property provided as security, as determined by an independent appraiser appointed by the Bank, assuming that it is exploited in full according to the transformation project referred to above.

Certain European legal systems contain a requirement that sureties/insurance have to be provided in order to guarantee the return of advance payments/deposits. Under certain legal systems these amounts must always transit through the current account of the banks financing the operation.

Timing and cash flows for a real estate development project

FIGURE 6.17 Timing and cash flows for a real estate development project

Surety facility

The lowest of the following amounts will be made available:

• €18.000.000;

• 100% of the advance payments/deposits received from end buyers of the units built within the property provided as security, paid into an escrow account with a pledge in favour of the Bank.

The independent appraiser may be a surveyor employed by the bank or an independent professional, and is also required to draw up works in progress reports for the purpose of drawdowns. A form of project monitoring is also specified, for which specialist individuals (watchdog) are responsible for regular checks that construction work on the property is continuing in accordance with the schedule provided to the bank upon conclusion of the loan agreement (and in particular according to the tender contract or contracts), and in accordance with the business plan agreed on. The purpose of this is also to ensure that timely action is taken if unexpected events occur during construction which result in delays in work and inevitable increases in construction costs and financial charges. The maximum financed amounts for both financing lines are shown in Figure 6.18.

Loan amount

FIGURE 6.18 Loan amount

INTEREST RATE AND MARGIN

Floating-rate (EURIBOR 3 months) + margin, paid quarterly in arrears. Development facility

• 3.5% on an annual basis during the construction stage;

• 2.5% on an annual basis after completion of construction.

GUARANTEE FEE

1% on an annual basis, paid quarterly in arrears.

FIGURE 6.19 Interest rates for real estate development project lending

The entire analysis is conducted assuming a value for the EURIBOR (0.5%) which is higher compared to market conditions at the time the loan is granted (0.2%) with the intention of probing the financial sustainability of the project in the event of an interest rate rise. The test could also be repeated according to different base rate scenarios. The rates used for the calculation are converted on a quarterly basis.[2] Figure 6.19 shows the interest rates for every financing line.

PRINCIPAL FACILITY

This will be drawn down in various instahnents, with amounts not lower than €500,000 at intervals of at least one month depending upon the WIP, as ascertained by an independent appraiser appointed by the Bank, subject to compliance with the prerequisites referred to above.

GUARANTEE FEE

Made available in instalments in return for payment into the escrow account of the corresponding advance payments/ deposits received from end buyers. The sureties line is in turn guaranteed by the advance payments made by the promissory buyer.

The facility could also be provided with a different guarantee (such as a corporate guarantee issued by the sponsors), depending on laws in the country.

TERM

Three years.

The term must be consistent with the time-scales for construction and marketing activities.

REPAYMENT

The loan will be repaid in one single instalment upon maturity, or alternatively in line with concluded sales for the properties built. In particular, upon each individual sale, the borrower will be required to repay at least 125% of the amount of the loan allocated to the corresponding unit in accordance with criteria to be agreed upon between the bank and the borrower.

Full or partial prepayment of the loan will be pennitted upon any expiry of quarterly interest periods subject to a minimum of 30 day notice in writing to the Bank and subject to the payment to the Bank of breakage costs (if any) plus prepayment fee equal to 50 bps for each full year of prepayment before maturity.

Repayments made in line with the sales of properties as described above will not be regarded as advance repayment.

In line with the completed sales and partial repayments of the loan, the bank will arrange for the parallel redemption of the mortgage, following return of the sureties issued against the guarantee fee.

After ownership of the property has been transferred and the price has been paid in full, the surety no longer has any effect and must be returned to the bank for cancellation.

LOAN STRUCTURING COSTS

1.25% of the amount loaned, to be withheld upon the first drawdown.

The structuring costs do not include the appraiser's fees.

COMMITMENT FEE

1.5% on an annual basis, calculated on the residual amount to be drawn down from the Principal Facility (the difference between the loan approved and the amount actually drawn down), to be paid upon conclusion of each quarter after conclusion of the loan agreement.

This is a commission due in respect of non-usage which remunerates the bank's commitment to maintain the facility which has not yet been drawn down for the period of time agreed. Within the example, for the purposes of clarity, it is assumed that there is only one loan agreement which immediately provides a facility for the full amount necessary in order to cover the construction costs. Normally various loans or tranches are granted depending upon the actual cash requirements of the project in order to avoid an excessive burden in the cost of the commitment fee. Due to this commission, it is very important to forecast the expected cash flow of the project in order to avoid committing to a large amount of unnecessary money.

OTHER COSTS

In addition to the costs relating to the appraiser's estimate and checks regarding the works progression reports drawn up by a surveyor instructed by the Bank, the borrower will bear all other costs incurred by the Bank relating to the preparation, conclusion, and administration of the loan.

The borrower undertakes to pay these expenses upon first demand on the basis of a budget agreed to in advance with the Bank, which may not exceed a total of Euro ...

Figure 6.20 shows in details the evolution of the loan facilities (construction line and bank guarantee).

SECURITY

• First ranking mortgage over the Security Property as guarantee for the Main Facility;

• Payment into an escrow account with a pledge in favour of the Bank of all income received as advance payments/deposits relating to the sale of the properties as guarantee for the Guarantee fee;

• Payment into an escrow account with a pledge in favour of the Bank of all income received from the sale of the properties, as well as the relative advance payments/ deposits not used to cover the Guarantee fee; it is acknowledged that these amounts may be used in order to cover the cost of construction of the property provided as security, with a parallel reduction of the amount loaned;

• Pledge over shares of the SPV;

Assignment to the Bank of all rights, including receivables, resulting from tender contracts relating to the transformation of the property provided as security, which must be drawn up in a manner approved by the Bank;

• Assignment to the Bank of a performance bond payable upon first sight, equal to 10% of the total value of the construction tender as guarantee for completion of the work;

Assignment of the rights and receivables resulting from the all risks insurance policies covering the property provided as security, issued by primary standing insurance companies approved by the Bank and pledged to the Bank;

• A commitment by the borrower's shareholders to guarantee payment of any costs not specified in the business plan enclosed and ensure that the bank's claims take priority over any amounts due to them, or over any infra-group loans.

The security package covers all current and future claims of the bank against the borrower under the finance documents.

The loan facilities

FIGURE 6.20 The loan facilities

COVENANTS

In addition to the standard contractual conditions for operations of this kind (including but not limited to: default interest, a prohibition on the modification of the company object, a prohibition on the assignment of rights/obligations vested in the borrower under the loan agreement), and the conditions precedent applicable in the event of breach, the borrower shall comply with the following additional requirements:

• The Loan to Value Ratio (LTV, equal to the ratio between the Principal Facility and the completion value attributed to the property provided as security by an independent appraiser approved by the Bank) may not exceed 60% at any time during the term of the loan;

• The Loan to Cost ratio (LTC equal to the ratio between the Principal Facility and the cost of the works financed, including the cost of the land) may not exceed 75% at any time during the term of the loan;

• A commitment by the borrower and their partners not to grant third parties real rights on the borrower's assets and/or shares unless approved in writing by the Bank (Negative Pledge);

• A commitment by the borrower and its shareholders not to change the current shareholder structure unless approved in writing by the Bank;

• A commitment by the borrower to provide the Bank with an up-to-date report on its accounting situation every half-year;

• A commitment by the borrower to provide the bank with copies of extracts of all escrow accounts with a pledge in favour of the Bank in accordance with this loan agreement at monthly intervals;

• A commitment by the borrower to provide the bank with its accounts each year within 30 days of approval along with those of parent companies and companies from the group of origin;

• The grant to the Bank of the right to arrange for appraisers instructed by it to visit the property provided as security at least once per year in order to enable monitoring of compliance with banking legislation and adherence to works progression upon each drawdown.

DOCUMENTATION REQUIRED PRIOR TO CONCLUSION OF THE LOAN AGREEMENT

In addition to those typical for this type of operation (verification of powers of signature and company resolutions etc.), conclusion of the loan agreement will be conditional upon presentation of the following documentation: preliminary report prepared by the notary/lawyer instructed attesting full ownership of the property provided as security and the lack of any burdens and/or detrimental charges against it.

DOCUMENTATION REQUIRED PRIOR TO DRAWDOWN

In addition to those typical for this type of operation, drawdown will be conditional upon the presentation of the following documentation:

• A definitive report prepared by the notary/lawyer instructed attesting:

• ownership of the property provided as security and that it is free from detrimental charges;

• registration of the first ranking mortgage in favour of the Bank;

• Copies of the loan agreement;

• Appraisal of the value of the property provided as security upon drawdown by an appraiser approved by the Bank;

• Verification of the start of work and the progression of work by an appraiser approved by the Bank;

Building regulations due diligence.

For the Guarantee fee:

• Verification of payment into an escrow account with a pledge in favour of the Bank of the full amount of the income received as advance payments on the sales of the properties.

For the full term of the loan it is necessary to monitor compliance with the covenants, including in particular the ratio between expected OMV[3] and debt (Figure 6.21).

Figure 6.22 finally summarizes the cash flows and loan facilities.

  • [1] For more details on development projects and their financing please see also Brueggeman and Fisher (2011).
  • [2] The formula to transform an annual interest rate into its correspondent quarterly rate is as follows: r4 = (1 + r)1/4 -1, where r4 = quarterly interest rate and r = annual interest rate.
  • [3] In this example the OMV is calculated as the weighted average of the construction cost and the sale price (after completion costs) in line with the percentage completed.
 
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