A quick guide to non-bank property development financing

October 17 2024 by Andy Wong

Property developers have a wide range of funding options available to them when it comes to financing their projects. Beyond traditional bank loans, non-bank financing has become an attractive option for property developers looking for flexibility, quicker approval processes and higher-risk tolerance. In fact, in recent years, many property developers in Australia have turned to non-bank financing as an alternative to traditional bank loans. This guide will explore the various types of non-bank funding available to property developers, including pooled and contributory funds, high-net-worth investors, family offices, investment banks, non-bank institutional lenders, hedge funds and hybrid models. Understanding the differences between these funding sources is essential for property developers seeking to raise capital efficiently while balancing the risks and benefits associated with each option.

Why Property Developers Turn to Non-Bank Financing

While banks have long been the cornerstone of property finance, their lending practices are tightly regulated by the Australian Prudential Regulation Authority (APRA). These banks, known as Authorised Deposit-Taking Institutions (ADIs), are subject to strict capital controls and risk management guidelines. Although ADIs offer affordable financing, the stringent criteria they apply can make it challenging for property developers, particularly smaller and new developers, to secure loans for property development projects.

Today, most property development loans are provided by Australia’s four major banks, with a few smaller financial institutions offering limited financing options. The low interest rates that ADIs offer are highly appealing, but these come at a cost: slow, bureaucratic approval processes and rigid lending criteria. For property developers who require faster approval or who are pursuing projects that fall outside the low-risk categories banks prefer, non-bank lenders provide a more viable alternative. Non-bank funders often offer more flexible loan terms, quicker decision-making and higher-risk tolerance, making them an attractive option for many property developers. Below is an overview of the key non-bank financing options available in the property development market.

Pooled Mortgage Funds or Trusts

Pooled mortgage funds involve raising capital from multiple investors which is then used to lend to borrowers such as property developers. These funds offer a key advantage to property developers: the money is usually already available, which minimises the risk of delays in accessing funds. Regulated by the Australian Securities and Investments Commission (ASIC), pooled funds provide flexibility in pricing and decision-making, as the fund managers have significant discretion to approve loans without needing to consult individual investors. The pooled mortgage fund industry experienced significant challenges during the Global Financial Crisis (GFC), but it has since rebounded, with many funds thriving once again. For property developers, pooled mortgage funds offer quick access to capital and the security of dealing with an established, regulated entity.

Direct Mortgage/Contributory Funds

Direct mortgage funds differ from pooled funds in that they raise capital specifically for each individual transaction, rather than pooling funds across multiple projects. While this approach allows for greater flexibility in tailoring investments to specific risk profiles, it also carries higher risks for property developers. In particular, there is the potential that the necessary funds may not be raised in time, or that investors could withdraw their support before the transaction is completed. These risks can be mitigated if the fund has a strong track record or if the transaction is underwritten by a larger entity. Despite the higher risk, direct mortgage funds can provide tailored funding solutions for property developers who need flexibility and are willing to take on additional risk.

High-Net-Worth Investors

Many high-net-worth individuals choose to invest in property developments, either through direct lending or via mortgage funds. These individuals often seek higher returns than those offered by traditional investment vehicles, and their willingness to take on greater risk can make them ideal partners for property developers pursuing higher-risk projects. High-net-worth investors offer significant flexibility, providing property developers with the ability to secure funding quickly and without the lengthy bureaucratic processes that accompany bank loans. However, these investors often require higher interest rates and may impose strict legal protections to safeguard their investments, which can add complexity to the transaction.

Family Offices

Family offices, which manage the wealth of high-net-worth families, are another important source of non-bank financing. These offices typically seek higher returns than what traditional investment vehicles offer, and the private lending market is a key area where they can achieve these returns. Family offices may lend their funds directly to property developers or may work through other third parties who manage their credit analysis, loan submissions and loan administration on their behalf. Some family offices pool their resources with other offices or invest in mortgage funds, making them versatile and flexible players in the property finance landscape. Their ability to move quickly and tailor investment strategies to specific projects makes them attractive partners for property developers.

Investment Banks

Investment banks play a significant role in financing large-scale property developments, particularly in the corporate sector. These financial institutions specialise in complex financial transactions, including property finance, and have shown increasing interest in the sector due to its potential for strong returns. However, investment bank funding tends to be more accessible for large-scale corporate developments rather than for smaller or mid-tier property projects. Overall, investment banks are important players in property finance and can provide substantial amounts of capital for large and complex developments.

Non-Bank Institutional Lenders

Non-bank institutional lenders include superannuation funds, large corporations, real estate companies and hedge funds that lend money from their balance sheets. These institutions typically focus on large-scale commercial property transactions and offer certainty in terms of the availability of funds. However, like ADIs, they may also be subject to some bureaucratic processes, although they are generally more flexible than traditional financial institutions. Non-bank institutional lenders are important players in the property development finance space, particularly for large projects that require substantial capital.

Hedge Funds

Hedge funds have become increasingly involved in the Australian property finance market, attracted by the strong returns available. Some hedge funds have acquired established Australian lending companies, while others provide direct loans to property developers. Hedge funds tend to have a high-risk tolerance and can make quick decisions, providing the kind of flexible, high-return financing that traditional ADIs avoid. For property developers pursuing high-risk, high-reward projects, hedge funds can be a valuable source of capital, although the cost of borrowing from these funds is typically higher than from other sources.

Hybrid Models

Hybrid funders combine elements of multiple funding types, such as having their own capital while also originating transactions for other lenders. These hybrid models allow funders to co-lend with other institutions or work with multiple sources of capital on specific deals, providing greater flexibility for property developers. Many hybrid funders have the ability to adapt to the needs of individual projects, making them an attractive option for property developers who require a bespoke financing solution.

Conclusion

Non-bank financing has become an increasingly important option for property developers in Australia, offering greater flexibility, quicker approvals and access to higher-risk funding than traditional banks. Whether property developers choose to work with investment banks, family offices, mortgage funds, high-net-worth individuals or hybrid models, each funding source presents its own advantages and risks. By understanding the various non-bank financing options available, property developers can make informed decisions that align with their project goals, risk tolerance and financial strategies. In an ever-evolving property finance landscape, non-bank financing continues to play a crucial role in supporting the development of new and innovative projects across Australia.