BLD60608

CONSTRUCTION ECONOMICS
MANAGEMENT

DEVELOPMENT FINANCE &

PROJECT FUNDING

BY
NURULHUDA HASHIM
 Development Finance - Introduction

Funds that are required to build a In order to maintain liquidity

housing or commercial development (availability of cash), developers often
can be quite extensive – rare for opt to be financed by a bridging loan.
developers to fund the entire project
on their own

2 main forms of financing for property Bridging loan is then followed by

development projects are commonly another party providing loans to
used in Malaysia:- buyers of the property being
1. Bridging Loan (short term) developed; that is known as end-
2. End Financing (long term) financing

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Development Finance
Usually required to pay for “costs of
production” also commonly referred
SHORT TERM
to as bridging loan:
FINANCE
“Bridging Loan” • Purchase of land
• Building & Infrastructure costs
• Professional fees
• Development cost
• Promotion and marketing costs

Bridging
Loan

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Short Term Finance - Bridging Loans “BL”
• BL are used by developers to fund their GCC (Gross
Construction Costs).
• BL are usually charged at a higher interest rate
compared to mortgage loan but lower than other types
of financing such as overdraft facility.
• High interest charges reflect the high risk that lenders
face should developers fail to meet their financial
obligations.
• Risks could be due to failure to attract sufficient buyers
for the development or project failure due to other
reasons (incompetency, wrong estimation etc).
• Most developers opt for bridging loan despite high
interest charges to fill the gap between the time when
the project commences and long-term financing can be
obtained.
• Helps ease cash flow of developer during the
construction period pending receipt of proceeds from
end purchasers or their end- financiers.

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Long Term
(End) Finance 2. Long term finance is to enable
developers to repay their short term
borrowings by:
• Outright sale to realize profits
• Seek other investors to share in the
ownership of the property which is
retained as an investment
• The choice to retain the property as an
investment or sell it to realize profits
depends largely on developer’s
motivation, their business model and the
prevailing market conditions.
• Developers may be motivated by long
term returns outlook (investor
developer) or just for short term gains
(trader developer)
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Long Term
(End) Finance
• Financial institutions that provide
bridging loans to developers
sometimes also finance property
purchasers (end-buyers) – long term
financing.
• Whilst this doubles the customer
base, it also increases the risk of
default by both parties for the same
project.
• Risk of default by any one party can
be substantial, hence financial
institutions usually only offer to loan
a portion of the project - remaining
portions are financed by other
institutions.

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Types of Financing
Some of the types of financing offered by
financial institutions (banks) are:-

• Residential development financing

• Land acquisition financing
• Commercial development financing
• Real Estate Transaction Finance
• Bridging finance
• End finance (for end purchasers)
• Customized financing packages to
meet individual developer’s needs

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Sources of Finance

1 Financial Institutions
2 Building Societies
3 Property Companies
4 Joint Venture Partners

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i. REITs – Real Estate Investment Trusts
ii. PCF – Property Crowd Funding

6 Government Assistance
7 Private Individuals

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1. Financial Institutions
• FI are institutions licensed by the central bank to
operate financial business and include commercial
banks, investment banks, pension funds,
insurance/life assurance companies, brokerage
firms, investment trusts and unit trusts.
• They invest in property directly and indirectly
through ownership of shares in property
investment companies and development
companies;
• Direct property investment includes:-
 Owning completed and let (rented) developments;
 Forward funding or direct involvement in development
schemes
• Lending criteria varies depending on number of
dwellings built; FI will expect a deposit of 20-30%
(equity) and borrowers need to demonstrate ability
to service the loan by submitting a highly detailed
plan project scope, area profile, expenses, risk
assessment, property value and projected sales.
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1. Financial Institutions

• Traditionally commercial banks have

been the provider of short-term
development finance.
• Long-term investment finance were
usually provided by insurance companies,
pension funds and investment trust funds.
• Financial institutions that take on the role
of the short-term financier also termed as
“forward funding” of development
schemes.
• This is done by providing interim
development finance to a developer and
the agreement to purchase the property
upon completion of the scheme.

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 1. Financial Institutions

• Financial institutions tend to minimize risks and adopt a conservative approach

to any investment as they are the trustees of other people’s money and are
therefore under constant pressure to perform
• By investing in different assets, they give diversity to their investment portfolios
and hence spread the risks involved
• Although they are long-term investors, they pay particular attention to the
short-term performance and decisions are strongly influenced by the recent
performances of each type of asset.

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 1. Financial Institutions
• In Malaysia, the only pension fund is the Employee
Provident Fund (EPF), which is the national
compulsory saving scheme for individuals
employed in the Malaysian private sector;
• Government employees have the choice either to opt
for the government pension scheme or contribute
towards the EPF;
• EPF is publicly managed and financed through
contributions amounting to 23% of the
employees' payroll; employee contributes 11%
and the employer 12%. Employers are obliged to
contribute at least 12%, but can voluntarily pay a
higher rate.
• The contributions paid by the contributors are
invested to achieve income and capital growth to
the funds in order to declare annual dividends
which is added to the contributions/savings and
paid when employees reach 55 and 60 years old
(retirement)
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 1. Financial Institutions

• Life assurance companies and insurance companies invest the premiums

on life and general insurance policies, respectively to ensure long-term
income growth to meet payment obligations when they occur.
• Unit trust are managed by financial institutions who offer investment
management services
- Unit trust holders ·comprise of small investors and institutions who are
unable to take the risk of direct investment .
- Will manage a portfolio of shares on behalf of the unit holders to obtain
a spread of risks.

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 1. Financial Institutions

• Merchant banks are essentially

entrepreneurs which arrange and
supply finance for particular
purposes.
- Involves substantially more risk
than that undertaken by
commercial banks but charges
higher rates of interest. · Irr.-,• .!

- Ability to structure finance

requirements for a project to
make the attracting of funds
possible enables the merchant
banks to charge higher rates of
interest and often demand
equity participation in the
project.

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 2. Building Societies
• Building Societies provide • Difference between building
mortgage finance to private house societies and banks
buyers. They do not participate – Bank are listed on the stock
directly in commercial development. market, they are businesses and
There are two building societies in therefore work in favour of
Malaysia:- those who invest in them,
- Malaysian Building Society specifically their shareholders.
Berhad (MBSB). – Building societies are not
- Borneo Housing Mortgage commercial businesses, they are
Finance Berhad (BHMFB). ‘mutual institutions’; owned by
and working for their customers
(depositors).

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 3. Property Companies
Two broad categories of companies
that participate in development are
investors and traders:-
• The investor type of developer,
referred to as a property company
is also a source of long-term
finance; property purchased as
investment for their portfolio as
well as retaining their own
developments.
• The trader type of developer
referred to as development
company and the property
company are financed by their
own capital and that of their
shareholders and partly financed
by borrowing money either short-
term or longer.
• Some of the major property companies
may have liquidity available which is
not ear-marked for immediate use.
• This surplus funds can be loaned to
another property company in exchange
for shares in the proposed development
or in exchange for participation in the
major property company which the
property company is prepared to
borrow to fund the project.
• Equity finance can be raised by issuing
various forms of shares in a company
with the investors directly participating
in the profits and risks of the company
or by floating on the Stock Market and
selling shares to raise money.
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 4. Joint Venture Partners
• A development company may raise finance or secure the acquisition of land
by forging a partnership or joint venture with a third party to carry out a
specific development or whole series of development projects.
• In return of the finance raised or and acquired, the developer gets a share in
the profits of the development scheme or the joint venture company.
• The basic principle of the JV partnership is to secure either finance or land in
return for a share in the profits of the development scheme or the joint
venture company
• The joint share given to the third party with depend largely on the value of
their contribution combined with the extent they wish to participate in the
risk of the scheme.

https://www.theedgemarkets.com/article/s-p-setiatradewinds-jv-
signs-master-agreement-cheras-dbkl-flats-redevelopment-plan
https://www.thestar.com.my/business/business-
news/2019/03/07/s-p-setia-jv-signs-master-agreement-with-dbkl

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5 i. Real Estate Investment Trusts “REITs”
• REITs are shares of commercial properties listed on the Bursa Malaysia stock
exchange that is owned and managed by professionals or property developers.
Properties under a REIT are income-generating real estate such as shopping malls,
hospitals, factories, warehouses, offices and farms
• REIT companies own or finances income-producing properties eg. IGB REIT for Mid
Valley and Sunway REIT for Sunway Pyramid;
• REIT are similar to unit trusts where investors pool together their money and a
manager decides which property to buy and/or sell - mainly for office buildings,
shopping malls, hotels and factories & warehouses;
• Returns are provided to unitholders in the form of dividend payments from
investment income - rental, through capital appreciation from changes in market
value and capital gains when a property is sold off at a profit.

Acquisition and/or
Invest in shares
capital investment

Rental income or
Distribution interest payment

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 5 ii. Property Crowd Funding “PCF”
• Budget 2019 announced a new provision
for an alternative financing avenue for
first-time homebuyers through a
property crowdfunding scheme.
• only eligible properties and homebuyers
will be allowed to participate:-
 Malaysian, at least 21 years old, and a
first-time homebuyer;
 property must be occupied by the
homebuyer at all times;
 permitted to rent out rooms in the
property during the scheme's tenure;
 financing limit up to 90% of the value of
property costing < RM500K.

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 5 ii. Property Crowd Funding “PCF”

https://www.theedgemarkets.com/article/sc-revises-property-crowdfunding-guidelines
https://mypf.my/2018/11/06/p2p-crowdfund-property-purchase/

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6. Private Individuals
• Private individuals do purchase property investments at the lower end
of the market:-
⁻ Tend to concentrate their purchase on secondary and tertiary
commercial property with high yields
⁻ Usually attracted to high yield properties but participation in the
lower end (small scale development) of the property market is very
risky, as it involves intensive management.
• There are also some wealthy individuals who privately finance property
development. The existence of these sources are not normally published
and their money are usually made available through financial advisers,
merchant banks or other agents.

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7. Government Assistance
• There are various grants and tax
concessions and other forms of assistance
available from the Government to
developers directly or through partnership
with local authorities
• Most of these incentives are designed with
specific purposes in mind and are intended
to alleviate local or regional problems
particularly unemployment.
• Most of the schemes are aimed at the end
users of the facilities to be aided eg. tourism,
agriculture or manufacturing businesses.

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Project Funding

Generally developers will approach commercial banks for project funding and banks will
provide the loans based on certain criteria:-
• Central Bank (BNM) policy & guidelines on lending
• The policy of the bank in relation to its preferred lending at any given time.
• Within these restrictions, branch managers have a high degree of discretion in
approving individual applications.
• Developers with established good track record with any branch of the respective
bank will receive more favorable treatment than others, both in the availability of
money and the loan terms.
• Most methods of applying funds for development projects are based on the
following funding requirements:-
a) Short-term finance, sale on completion
• Interim or bridging finance which assumes that the developer uses a bridging
loan (i.e. short-term loan) to cover the costs of acquiring the land and the cost
of construction, and sells the completed development/property outright,
retaining no long term interest in the project
• Interim finance likely will be supplied by a commercial or investment bank.
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 Project Funding
a) Short-term finance, sale on completion
Aspects of financing that have to be considered are:-
i. Size and timing of the lending
• Most banks are unwilling to lend the
whole amount of the finance required
for the whole development period.
• Developers will have to convince the
banks that the proposal is extremely
viable or be able to offer assurances
that additional finance is available.
• In most cases, the developer will be
required to supply some element of
the funding in cash, either from his
own resources or through a third
party.
ii. Quality of the security being
offered for the loan
• Normally this will be the site
itself, but the bank may well
require additional collateral.
• Banks will seek to minimize its
own ‘exposure’ on the project;
will try to ensure they have
maximum security and minimum
risk on the transaction.
Developer may have to give
additional security such as
personal guarantees.
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 Project Funding
a) Short-term finance, sale on completion
iii. Details of the payback
arrangements
• Bank needs to ensure it will be able
to recover its investment in the
agreed time.
• Penalties may be expected in
addition to the normal interest if
the loan is not repaid on time.
• The bank may want the right to the
first tranche of monies recovered
through a sale or letting prior to
any other distribution of such
income.
iv. Cost of loan to the developer
• Projects which the bank perceive as being
of high commercial risk and possessing
less than absolute security for the lending
may only be financed at a correspondingly
high rate of interest.
• Range of interest rates will be in the range
of 2% above BLR (for well secured low
risk projects) to 5% above BLR for the
more speculative development.
• There may also be an agreement for the
rate to fluctuate according to some pre-
agreed formula
• The bank may also require a fee for
making the funds available, usually a
percentage of the loan; this sum may be
added to the loan.
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 Project Funding
b) Developer retailing; long-term interest
Where the developer wishes to have equity participation in the long-term growth
potential of the projects, more sophisticated methods must be employed:-

i. Mortgage finance ii. Sale and leaseback

- The developer repay the short-
term borrowing by giving a
mortgage on the completed
project to a financial institution
in exchange for sufficient funds to
cover his capital outlay plus
accrued interest.
.
- Mortgage funding is usually not
more than two thirds of the
capital value of the completed
development; the developer has
to ensure that the total
development cost is less than two
thirds of the completed value.
- The developer sells the project upon
completion to the investor and at the same
time takes a lease on the development
from the investor at a pre-arranged rent.
- Rent is calculated so that the investor obtains a
reasonable rate of return on the purchase
price he has paid.
- The developer then gains a ‘profit rent’ i.e. the
difference between the rent paid to the
investing institution and the rent the
developer receives from the tenants to whom
he sub-lets.
- The developer also enjoys participation in the
growth of the rental income at rent reviews.

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Project Funding
The funding requirements for private
sector residential development are
based on the assumption that the
housing are for outright purchase and
not for rent:-
• Larger development companies
are likely to obtain funding
through short-term loans, using
pre-agreed overdraft facilities and
medium-term loans from
merchant or clearing banks
• For smaller development
companies, medium-term loans
would be tied to development of
specific sites each of which would
be financed on the basis of its
viability. The ‘facility’ or
‘commitment’ fee would be
payable.
• The difference between commercial and
residential projects is residential development
can be divided into smaller parcels – phases
which can be started and completed according
to market demand. This allows the developer
to recover costs prior to completion of the
whole project and will influence financing
requirements.
• The provision of long-term finance for housing
is made to the purchaser (the end-user) i.e.
‘end financing’. But such funds are of interest to
the developer as the effective demand for
housing will depend on the funds available to
the purchaser.
• The security for the loan is the dwelling itself
and the loan is facilitated by way of a mortgage
agreement usually up to 90% of the lending
institution valuation of the property and for a
period not exceeding 30 years or up to
borrower’s age of 65.
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END

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