“I want the cheapest rate” is one of the most common phrases heard in Banking & Finance.
But, is the cheapest rate always the best option?
Not always, and here’s an example why.
We recently had a residential property developer come to us with a pipeline of projects over the next 12 to 24 months. This Group had traditionally held all of their financing arrangements with the major Banks – the key benefit, they believed, was obtaining a very good interest rate.
As part of our process of gaining an in-depth understanding of our clients (beyond just the project at hand), one of our first questions to the developers were “what are the Top 3 most important things for your business?”, and then ordered them in priority. Their response –
- Get started on projects as soon as possible (“speed to market”)
- Maximise the debt leverage on the projects
- Funding costs
Although no borrower wants to pay more interest & fees than they have to, when thinking through these priorities, this developer actually put speed to market and leverage as higher priorities than cost – neither of which are factors that banks generally lead-in.
Although non-bank finance can be materially more expensive (generally two to three times more expensive than bank finance), we often find that this is only the case on the surface. Dig a little deeper and that cheap finance can start creating costs elsewhere, particularly including:
- Lower Net Realised Value can often occur as a result of trying to get the hurdle pre-sales away as quickly as possible, with higher sales commissions to incentivise agents to achieve results and/or lower sale prices or incentives to incentivise buyers to act quickly. This factor alone can easily outweigh the cost premium of non-bank finance, before even considering the next points.
- Longer time to start construction (and therefore to get your capital & profits back out the other end), which equals:
- more finance cost while sitting there waiting to start (if the land is debt-funded)
- and/or lower return on equity (particularly IRR on equity)
- AND less projects that you can do over time (e.g. if you can be in & out of a project in 15 months instead of 24 months, then over 10 years you could have completed 8 projects instead of 5)
- Return on Equity is often overlooked but can be a major factor. Put simply, if you only had to put in 50% of the equity into a project and make only 75% as much profit, then you could do 2 projects instead of 1, and make 50% more profit across the two. Alternatively, as many developers use investors for some of their equity, the lower bank debt cost at a lower leverage level can cause the cost of equity to increase, wiping out a lot of the benefits.
The old adage “time is money” is absolutely true, particularly for property developers. Holding out for the cheapest funding option is not always the best play, particularly when there are a number of solid, well established and highly reputable non-bank funders in the market looking to support the property industry.
If you have a property project and are wondering about your potential options, we have the experience and the track record to assist you through sourcing and assessing the options, supported by our very deep & broad relationships in both the bank and non-bank markets.