[+] Safe Harbour: Lenders Back JV Deals in Construction Chaos

Clearly it is working out well for 5Point, which recently celebrated wins at the Master Builders’ Housing & Construction Awards for a Highgate Hill residential development, as well as its Perspective 488 Palm Beach project with Sherpa Property Group.

Funders have undergone a 180-degree turnaround in how they approach alternative project models, says Dove.

“Previously it was seen as better to have that transactional separation,” he says.

“Developers could take on a lot more risk and banks were protected, whereas now those banks are looking for the comfort of shared risk, where the builder has greater opportunities and likelihood of completing development without insolvency hanging over their head.”

Funder perspective 

MaxCap head of direct investment Simon Hulett said that while it was not a new concept, JVs could help support builders in a challenging period. The non-bank lender has struck deals with developers across the country on projects, including Milieu (pictured in the main image).

“It’s not unusual for builders to be invested in the projects they are delivering, but that can take different forms and it continues to evolve, and every builder and developer is different,” Hulett says.

“At the smaller end of the scale it might be something that’s a bit more prevalent, where builders are working to quite small margins so in order to derive an enhanced return they are willing to do those deals.”

Executive director and chief investment officer at Pallas Capital Dan Gallen says that the CRE debt and equity investment manager has built its own funding model to cater for the nuances of joint venture arrangements.

“Even then, there is no rule book for how the profits and income of these projects is apportioned between the partners, so any model needs to be adaptable,”  Gallen says.

“This means that many ‘off the shelf’ models can be a bit clunky for modelling out joint ventures and non-standard profit-sharing arrangements.”

While serious due diligence is always undertaken, there are certain elements of a JV that might come under greater scrutiny.

“In terms of sponsor due diligence for JV funding, we require a thorough understanding of how the relationship between the parties will operate and any delineation of project deliverables and any profit and cost sharing provisions,” says Gallen.

“It also helps if the parties have worked together previously as this demonstrates their ability to work together through the ups and downs of a development.”

MaxCap’s Hulett agrees.

“It’s definitely a case-by-case proposition, which comes down to the relationships you have in place,” he says.

“If that’s a path you want to go down, you want to be confident in the alignment with their values and business, their ownership and senior leadership.

“Developments always experience challenges and when you experience those challenges you need to be aligned and work in a collaborative manner to deliver the best outcome, which is what we’re focused on, on a risk-adjusted basis.”

Construction sector blues

It’s no secret that times are tough in construction, with the final collapse of GCB Construction last week, or soaring construction costs forcing a $450-million Brisbane project to be abandoned.

Dove explains that given the issues with construction costs, exacerbated by workforce drains and fixed-price contracts, builders are also looking for other options.

“Costs are facing ongoing escalation each month and each quarter, so it’s difficult to expect a building contractor to take on risk with a set margin of contingency thinking that will be sufficient over 12 months to three years or more.”

It’s how you will manage that escalation, Dove says, something that the industry as a whole is working on, and can be done effectively in partnership with a developer on a more equitable playing field.

This more communicative and transparent approach is being considered in different ways by developers with efforts towards transparency and flexibility, especially when it comes to fixed price contracts.

While the JV model may not overtake more typical capital structures, it does have its benefits for a struggling sector.

“It might create too much uncertainty for industry and buyers at mass scale, but certainly it will give an opportunity to projects that may not ordinarily go forward, that would be too much risk alone versus reward. In a JV arrangement, you’re both going to take some risk and reward together,” says Dove.

Hulett says funders have been keeping a watchful eye on the sector.

“Three core elements that go into any feasibility are of course time, cost and revenue, those are the key things we really focus on,” he says.

“They have all been impacted in different ways, so how do you find the right opportunities to extract value out of certain segments of the market?

“There’s no silver bullet at the moment, and everyone is looking at the traditional funding models and challenging those models.

“When you think about a traditional capital stack, with senior debt, junior debt, preferred equity and all those different machinations, there’s some creativity that can be applied to attract capital into projects to activate them, and a lot of that comes down to track record, capability, and the less tangible things in terms of relationships and trust.”

Pitfalls of a JV

Pallas Capital’s Dan Gallen says the potential opportunity of JV models lies in the different skillsets, which can be brought together.

“[That gives the development] potential to provide great synergies and generate much better outcomes than if the partners were to develop in isolation,” he says.

“However, there is the human factor in these relationships. They don’t always work out and there is the risk of a JV dispute during delivery disrupting the project—that’s why looking at projects where the partners that are on their second, third or fourth development provides a lot of comfort that the two partners can work together over that 18 to 24 month period to deliver a project.

“Having a very clear and agreed process at the start of the project that dictates what happens in the event of a dispute is important, which may result in one partner buying the other out, for example.”