Finance plays a critical role in the real estate industry as it provides the necessary capital to purchase, develop, and maintain properties. Real estate investments require significant amount of capital, and finance enables individuals and businesses to access the funds needed to acquire and manage real estate assets.
Real estate by its nature is a capital intensive industry. The real raw material to scale up the business is Capital. The developers can scale up their game if capital is available at the right time.
The liquidity raised via finance at the right time and used for the desired purpose can significantly increase the ROI.
Many institutional lenders have evolved to understand the real estate business and designed various lending models. It’s great to see the focused lending teams who understand the inherent nature of the business and then offer lending products. The real estate developer can consider raising finance at the early stage in the project where the approvals are just received and the sales have started. The projects where the stage of construction has progressed, lenders look at such projects more positively as there is some established track record of execution and sales. The quality of capital available is way better in case of structured finance which gives more flexibility to developers for deployment of funds.
Sources of Real Estate Finance
Let’s explore some common types of real estate financing options available to developers and investors:
- Traditional Bank Loans: Traditional bank loans are commonly used to finance real estate projects. These loans typically offer competitive interest rates and flexible repayment terms. Developers can utilize these loans for land acquisition, construction, or refinancing existing debt.
- Construction Loans from NBFCs: Construction loans provide short-term financing to cover the costs of constructing a property. These loans often have higher interest rates due to the higher risk associated with the construction phase. However, they can be tailored to match the project’s cash flow requirements and typically offer interest-only payments during the construction period.
- Joint Ventures and Partnerships: Collaborating with other investors or developers through joint ventures or partnerships is an alternative financing option. By pooling resources and sharing risks and rewards, developers can access additional funds to undertake larger projects.
- Private Equity and Venture Capital: Private equity firms and venture capitalists are increasingly participating in real estate investments. These entities provide capital in exchange for an ownership stake in the project or the potential for significant returns upon completion and sale of the property. This source is limited to organised and especially listed developers.
- Real Estate Investment Trusts (REITs): REITs offer an opportunity for individuals to invest in real estate without directly owning properties. REITs pool funds from multiple investors and use them to invest in various real estate ventures, including construction projects. Investors can benefit from regular dividends and potential capital appreciation.
Financial institutions such as NBFCs (Non Banking Fiancial Institutions) play a crucial role in providing access to capital for real estate projects. Here are some situations in which finance can be raised from financial institutions.
- Land Acquisition: When developers identify a suitable piece of land for their project, they often need financing to acquire it. Financial institutions can provide loans or lines of credit to cover the land purchase costs, allowing developers to secure the desired property.
- Construction Financing: Construction projects require significant capital to cover various expenses, including materials, labor, and overhead costs. Financial institutions offer specialized construction loans tailored to the unique cash flow requirements of these projects. These loans are disbursed in stages or based on specific milestones to ensure that funds are available when needed.
- Bridge Financing: In certain situations, real estate investors or developers may require short-term financing to bridge a gap between the cash inflow from customers and the amount of payment required to get the approvals (in the form of TDR, Premium FSI and other statutory payment) which is required in the early stage of business. Bridge loans, provided by financial institutions, offer interim financing until the long-term financing is secured by the developer.
- Inventory Finance (Last Mile Funding): Typically the projects which are at the last stage of development at times may have inventory of units which will be sold over the period of 12 to 24 months. In such situation, the real estate developer can consider the inventory finance where the future cash flow from this inventory will be discounted to current date and given to the developer. This inventory finance can be used for acquiring new projects or the use of funds for the general corporate purpose.
- Structured Finance: Structured finance in real estate refers to intricate financial arrangements where multiple projects are combined to create tailored loan products. The objective of such fund raise can be for the scenarios such as giving exit to a partner or use of the borrowed funds to acquire another project. Financial institutions along with professional advisors devise such solutions.
In summary, the liquidity plays key role in defining the real estate operations and the ROI. The institutional funds if used with discipline, can fuel up the progress and drive more profitability.
Real Estate project finance in nutshell is discounting the future cash flow of the project and making it available to the developer to execute the project faster. Raising finance has become relatively easier in the recent time. If the developer has good execution track record, they can take help of institutional finance to scale up faster. By leveraging appropriate financing strategies, such as inventory finance or structured finance, developers can secure the necessary capital to acquire land, construct properties, and maintain inventories. With a proactive approach to finance, the potential for growth, profitability, and success in the real estate industry becomes within reach. So, seize the opportunities, explore the financing options available, and embark on your real estate ventures with confidence and financial support.
CA Mohnish Katre
Partner in Finkoi
