Development finance - Capital structure considerations

Posted by Guelane Mansour on 4th October 2019 -

Returns vs. profitability

We all tend to want as much debt as possible whilst potentially overlooking the impact on the scheme’s profitability and, therefore, its economical viability vis-a-vis the lenders.

Being able to ascertain upfront the optimal debt quantum sustainable by a scheme is an important aspect of the funding journey as it will help anticipate the equity needed on day 1.

Maximising the development finance (via a stretched senior or a mix of senior debt and mezzanine funding) has its merits and considerations:

• Lower equity requirement implying better return on your equity

• Reduced profit (in absolute terms) and margins (due to higher financing costs)

The optimal capital structure is a trade-off between maximising returns and maintaining profitability levels.

Key performance indicators to bear in mind:

• Profit on costs: project’s margin. Most lenders will feel comfortable with a level of circa 15% post financing costs

• Return on equity: cash to be returned at exit which will be driven by the underlying structure of the equity (i.e. own funds, shareholder loan, third-party investors?)

• IRR: the expected annual rate of return that will be earned on the project or time-value of the investment

Ultimately, the optimal capital structure will be dictated by the minimum level of profitability required by lenders and the developer/investors’ internal hurdle rate/target return on equity.

There is no rule of thumb that one could apply to all schemes. Each project is unique with its own merits and considerations.

At Krios Capital Partners, we can support you in devising a successful funding strategy and help you secure your development finance package.

Should you have any enquiries, please get in touch at [email protected].

A one-stop-shop for real estate professionals seeking finance