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Investor Education: Investing in Construction Loans

October 18, 2018

Ivan Ruefli, Managing Director of Platinum Mortgage Investments Pty Ltd, provides the following opinion and insights to the current state of the lending landscape, as well as an investor information editorial on investing in construction loans.

INVESTING IN CONSTRUCTION LOANS

In recent months, the WA economic environment has stabilised sufficiently to incentivise property developers to secure well-priced development sites in quality and higher demand areas. Continual tightening of credit policy by mainstream banks has produced challenges for these developers and has created opportunities for Platinum.

Many of our term debt investment opportunities in the last 24 months have focused on assisting with bridging finance, to allow these developers to settle their options under which they have been holding these development sites.

The latest borrower trend has been an influx of opportunities to provide construction funding to these developers to begin their projects.  We are pleased to share that we have approved construction facilities for five suitable projects in the Perth Metro area, offering appropriately priced returns to our investors. In this communication, we thought it appropriate to provide some information on the benefits of investing in the progress draw component of construction projects.

INSIGHTS

Construction loans often carry additional returns to investors due to the increased risk of executing projects toward the realisation of Gross Realisable Value (GRV) on completion. Due to this execution risk, you will find that the returns offered on these loans are higher than term loans.

Our due diligence and risk pricing consider several factors in this regard. When it comes to construction loans at Platinum, we focus our due diligence on three critical elements, in addition to the Loan to Value Ratio (LVR).

1. Developer Experience – It is essential that there is development expertise and track record inherent in each project we fund – whether with the borrower directly or their executing service providers. We look for key factors such as actual cash equity in the project, successful track record on previous projects and their past borrowing history.

2. Builder Experience – While we require execution of all construction projects under fixed price lump sum agreements we also perform due diligence on the builder to ensure that they have adequate resources and experience to complete the project. We are inclined to favour cases where the builder has some minor financial stake in the project which helps maintain alignment and focus to completion. When we take these projects on, we do so under a tripartite agreement with the builder and borrower/developer which affords us the rights, in the event of a default, to take control of the construction project to protect our investors.

3. End Product Saleability We do not take on construction loans if we anticipate being in a position where we will need to facilitate the sale of the end product. That said, we always envisage the worst case in which we need to take control and sell the completed product to recover capital and interest. In this regard, the quality of the finished product, price point and competition in the area around the development are crucial considerations.

An often-misunderstood aspect of investing in construction finance is the risk profile of these investments compared to term debt investments.  As a project moves from commencement to completion, the level of risk in the investment reduces as the finished building or units near completion as discrete saleable assets with separate titles.

The risk profile of term debt remains stable as the liquidity of the asset does not usually change during the loan period. Assets that are transforming from their “as is valuation” to “as complete valuation” experience a decrease in liquidity during their construction period particularly in the early stages.

When the risk of a loan investment in existing property is compared to a construction loan, a significant defining difference is the liquidity (saleability) of the property. A half-built unit complex is less saleable than an old house on a prime development block. Once the development is finished the liquidity increases due to the following factors:

We will be offering prime opportunities to our investors to participate in progress advances as these construction loans progress towards completion. The opportunity to select investments from several projects simultaneously provides enhanced diversification benefits.

Also, we will advise you of likely forward capital return dates so that you can nominate investment in these construction draws to coincide with maturing investments.  Doing this will enable our investors to reinvest capital more efficiently with an added benefit of optimising yield across their portfolios.

Please feel free to contact Ivan Ruefli or our Investment Team at your convenience to find out more about increasing your capital deployment opportunities.

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