How to Finance Real Estate Development?
Real estate development is a professional activity that involves purchasing land for construction in order to build or renovate a structure (apartment building or house) on it, and then reselling it as a whole or in individual units (lot by lot). This activity requires continually finding sources of financing to bridge the time gap between:
- The purchase of the land or building, as well as construction costs, but also fees for design and project management firms, insurance premiums, marketing expenses, taxes, etc.
- Resale upon completion of the project.
To raise the necessary funds for their project, developers have several options: using their own capital, taking out a bank loan, pre-selling units through off-plan purchases… or turning to real estate crowdfunding. Let’s take a closer look at these different options, which often complement one another.
Equity or Capital: The Lifeblood of the Business
This is the cash that the developer holds in the company’s treasury. The developer is required to use these funds because the bank mandates that the developer have 10 to 30 percent of the project’s cost in equity before granting a loan. This money remains tied up for the entire duration of the project. The developer cannot access it until the loan has been repaid. Since the 2008 financial crisis, banks have become more cautious, which explains the gradual increase in the required equity ratio.
Bank Credit and Leverage
Given the amounts involved—sometimes several million—bank loans are a low-cost source of financing but often quite restrictive for the developer. Bank debt makes it possible, on the one hand, to raise the funds the developer lacks to carry out the project and, on the other hand, to benefit from leverage (a mechanism that maximizes the return on the developer’s equity), as long as the cost of the loan is lower than the project’s rate of return.
VEFA, or sales of properties under construction
Most real estate development projects today are carried out through VEFA, commonly known as “off-plan sales.” Even before construction begins, the future homes are offered for sale. Buyers must then pay up to 5% of the purchase price as a security deposit, followed by 25% when construction begins, and so on until the final payment upon key handover, which is often 5%. Here again, the developer receives the funds from VEFA sales as the construction project progresses and as banks disburse the mortgage loans. These presales are therefore a good way to secure financing at a lower cost because, instead of taking out a larger loan and receiving the proceeds from sales at the end of the project, the developer collects them throughout the project.
A New Option: Real Estate Crowdfunding
This relatively new financing method allows developers to raise equity—or, more precisely, “quasi-equity”—by soliciting funds from investors (individuals or professionals) through a crowdfunding platform. For investors, it is a way to lend amounts starting at €1,000 for short periods at an interest rate that often ranges from 7 to 12 percent.
For the developer, this is money that’s available quickly, isn’t tied up, and allows them to contribute the equity needed to secure a bank loan. For the developer, it’s much more advantageous to borrow at these rates than to have to sell equity in their company to investors to raise funds. As a result, they can develop more projects and grow their business by expanding more quickly. This explains the considerable success of this new financing method, as everyone benefits from it.
To finance a real estate project, developers typically combine various sources of funding. Real estate crowdfunding is emerging as an attractive option that facilitates access to bank loans while reducing the amount of equity tied up in the project. This allows developers to preserve their cash flow, take on a greater number of projects, and grow their businesses by leveraging this funding.