Preferential equity fills the gap

Preferential equity fills the gapChanging its funding strategy has helped a Brisbane property developer improve projected earnings for a new development and retain control of the project.Developer Visie Properties is expected to realise a return on equity more than 60 percentage points higher than expected after switching its funding strategy from a joint venture to preferential equity.Visie approached Development Finance Partners (DFP) for assistance in establishing a joint venture to fund its Lutwyche project, Zephyr, a 31-apartment medium-rise complex.But, after assessing the project, DFP advised against diluting equity and instead recommended a preferential equity solution.Preferential equity is a hybrid of debt and equity financing that fills the gap between bank-sourced funding and the developer’s contribution to a project.DFP associate director Mark Trayner says funding for Visie’s Zephyr project could be more effectively structured by preferential equity rather than a joint venture.”By analysing the requirement we were able to recommend a financing strategy that reduced the financing costs and allowed the developer to retain overall control of the project,” Trayner says.”A joint venture would have given away half the project. We advised the client that was not in his best interests and told him of the advantages of preferential equity,” which would allow the developer’s equity to be retained.DFP negotiated a preferred equity solution in conjunction with senior debt with a major bank. Trayner says Visie’s share of profit for Zephyr is forecast to be 56 per cent greater than the return using joint-venture funding, while the return on equity is expected to rise from 91 to 160 per cent.With construction costs on the rise, keeping projects on track is ever more important and there is increasing pressure on developers to commit to multiple projects at the one time.”It makes a lot of sense for developers to be looking at preferential equity at the moment, for a number of reasons,” Trayner says.Visie Properties director Warren Swanston says preferential equity was advantageous for Zephyr. With much of the groundwork already prepared – building and other approvals were already secured, and the project’s marketing program was in place – it reduced the risk for the preferential equity provider and helped speed up the process.”If you’re prepared to fund a lot of the extra expenses to get yourself to that point it’s sensational, because you get a lot more profit at the back end,” Swanston says. “It’s definitely something we’d consider again,” he added.In helping developers fund projects, DFP sees itself as a new class of consultant within the project team, the ‘financial engineer’.”If the financial structure of the project is not lined up and working with the rest of the development structure, you run into problems,” Trayner says.Read more here