The general objective of this work is to provide a description of the Principles for Bank Financing of Real Estate Projects and thus provide alternatives to solve the problems of placing investments in this type of project.
The importance of the issue lies mainly in deducting and minimizing the associated risks, since although this type of investment is very profitable, we also find that these operations have a high risk.
The main objective is to show in detail the fundamental principle of financing real estate projects and its components. In addition, observe a real experience, explaining each stage of the process and then through this example, provide a vision and practical guide on how to limit the risks with their different variables.
After the earthquake
To begin I would like to express the following phrase "Lending Money with Earthquake Engineering". Important analogy and basis of this work.
The uncertainty of estimating the next recessive cycle of the economy. Structural engineers have to design the structure so that in the normal course of things (small earthquakes) it is able to resist without problems, and that in the face of more serious earthquakes it deforms (even cracks) but never collapses. For that they use the concept of safety factor.
When credit is given, in the normal course of business the customer must not show any impairment in his ability to pay. However, in the face of events above expectations, we expect a deterioration in its normal generation, however this cannot be such that it affects the full repayment of our credit, and this will be provided by the second source of payment, which is equivalent to the coefficient of safety of analogy.
During the years 1998 and 1999, the crisis that affected the country's economy in general and especially the construction sector, with GDP growth rates of –0.4% and –10%, respectively, strongly affected the real estate sector, which It experienced a serious contraction in demand and consequently a violent decline in sales that, together with the significant increase in interest rates, set up an event that, according to the analogy in the opening paragraph, we can call the “Great Earthquake”.
If the situation experienced by the real estate sector in banking in general is carefully analyzed, it can be seen that most of the “structures” resisted, although some “cracked”. However, we could also observe that some of them “collapsed”, something unacceptable in the structural design (loss of people's lives) and undesirable in the art of lending money (loss of part of the capital).
A more detailed analysis of what happened in the failed cases shows us that although the Standard was correct (Sector Policy) and the design based on the Standard was correct (financing structure and conditions), which failed, in general, was the execution of the design (the follow-up). It is as if less cement and iron had been put into the mix (loss of slack). Additionally in some other failed cases, even the data for the design was incorrect.
The following chapters will analyze the Principles of Bank Financing for Real Estate Projects and their practical application to what has recently happened in the sector.
Specific objectives
The historical framework is proposed with the objective of showing the scenario and describing through the experiences that it has gone through and those that are lived today in our country, in terms of bank financing of real estate projects and that led many banks to organize special units to commercially serve this type of financing.
Additionally, it seeks to discover the description of the fundamental principle for this type of financing and thus analyze its different components, providing a theoretical basis for the analysis of real estate risk.
Then through a real experience, show some situations of financing real estate projects, then make an analysis of these examples and finally deliver a guide that serves to limit the risks and their variables. Seeking to anticipate and minimize the financial losses of banks in real estate project placements.
Historical Setting
Stage
During the last positive cycle of the country's economy and with the consequent boom in the real estate market, many banks organized special units to commercially finance this type of project.
The criteria used was similar to the organization of other banks, without significant difference in specialization or optimal standard per executive. Even in regions, in the main cities, executives who managed other banks in addition also managed real estate projects.
Although the executives had demonstrated a high capacity in managing other types of companies, their success in managing this other type of business was not extrapolated. Others had experience managing real estate projects, but in a very favorable business climate. The technical aspect was approached with appraisers depending directly on the executives, who, since they are not technical counterparts, favor the more agile.
Everything was very strongly based on achieving a guarantee / debt ratio equal to twice, with little emphasis on monitoring and control or treating this problem within the normal standards of lines of credit to companies.
There was a fairly general opinion that financing real estate projects assumed a low risk given that there was a guarantee that in most cases doubled the debt. In those days, most of the companies that carried out real estate projects financed with income from presales and part of the sales flow of other projects, their theoretical contributions presented in loan applications.
When real estate demand contracted, and therefore the pre-sales and sales flows were adjusted, the companies without solvency could not contribute their own. Thus, in the projects that were in the financing stage after the real estate point of no return (PNRI), the banks had to provide the missing financing to complete the works. Additionally, they had to agree to raise the guarantee of the financed units, only against the balance of the residual flow for the payment of the loans.
When drafts to construction projects and collateral flows were examined in detail, complete data were not available in most cases. Given the workload of some executives, in some cases it was really very difficult to have detailed and up-to-date information on the guarantees of the financed units and the respective associated flows.
The operating units in charge of ensuring compliance with what was agreed by the credit committees, had no knowledge of the principles of financing real estate projects or the tool to properly carry out their work.
There was the guarantee but not the flow! The information of the companies could not be counteracted with that of the banks! A line was approved and they always ended up financing more! But how can the above be controlled? Are the tools available?
The answer to these questions goes first by understanding the fundamental principles that operate in financing real estate projects and then analyzing the real cases and finally seeing how to limit the sources of risk observed.
This work aims precisely at that, first the concepts, then some real experiences and finally the most appropriate way to limit the risk of the identified controllable variables.
Theoretical framework
The Fundamental Principle
The Point of No Return of Real Estate Financing
Real estate financing begins, before any disbursement, with the land mortgage. Subsequently, this guarantee increases its value in proportion to the Bank's disbursements, according to the progress of construction. Once the construction is finished and the final reception is obtained, the guarantee takes the sale value equal to that studied when approving the loan. In the meantime, the value of the collateral is the value of the land, plus the investment in construction, minus the settlement cost.
If at some point very late in construction, the Bank has completed the entire line and the work is not finished, its negotiating capacity is very low and it may be forced to finish the work, ending the project with a more unfavorable financing structure than the one he initially took as normal risk.
This occurs because the collateral value of a construction site goes through high settlement costs. Obtaining the final municipal acceptance of a work is a crucial milestone in its value.
However, at the beginning of the financing, there is a period in which the Bank can liquidate the guarantee, mainly for the value of the land, covering its credit until that moment.
Therefore there is a theoretical point in the amount of financing, according to the progress of the work, in which there is indifference with respect to continuing until the end of the work or stopping the financing and paying off the guarantees until that moment.
We have called this point the Point of No Return for Real Estate Financing. (PNRI).
Unfortunately for the Banks, the PNRI is very low compared to the approved line, and most of the time, in a real estate financing, the banks find that they have to finish the work so that the guarantee adequately covers the credits.
Balance for Spinning Finish the Work
To avoid being forced to finish a work with a financing greater than that initially considered, (because it is above the PNRI), the following principle operates:
In each disbursement of the Bank, it must be ensured that the balance to be drawn from the approved loan is greater than or equal to the balance to be invested to complete the construction.
However, the foregoing is limited only to construction and does not consider the other expenses that must be contributed by the company and, when it refers to the "balance to be drawn from the approved loan", it must be understood that sales income, cost overruns have been discounted. and others that will be discussed later. Therefore, including all these elements, the above will be defined as the “net balance for drawing the approved loan”.
This leads to the following formulation:
In each disbursement of the Bank, it must be ensured that the net balance to be drawn from the approved loan is greater than or equal to the balance to be invested to finish the construction. Additionally, it must be ensured, in the credit evaluation stage, that the client company has sufficient solvency to contribute the other expenses not associated with construction or land that the Bank does not finance.
It should be noted that: if an advance is granted or financed with a proportional contribution from the company during the course of the work or partially financed with pre-sales, this principle is not being met.
Later we will see that even recognizing the above and being clear about how these exceptions are limited, it is possible to finance this type of projects within acceptable limits, we will also see that these exceptions are the first gaps that are lost when there are problems.
The Financing Structure
Any real estate project that the Bank finances must be financed.
To ensure the above, we must be clear about the financing structure for that project.
The most common sources to finance a real estate project are: Company, bank, Pre-sales income. There are other less usual ones such as: exchanges of m2 of the project once it is finished in exchange for the execution of the work (contracts, subcontracts, etc.) and suppliers.
A typical example is:
Financing structure of a Real Estate Project
Company Contribution
In the case of the company's contribution, this must always be made before the Bank's contribution. In some cases, a proportional contribution from the company is requested with the Bank (paripassu), which determines, at the beginning, that the construction, once the PNRI has passed, has the risk that the Bank will have to make the missing contribution.
Pre-sales revenue
In the case of financing with pre-sales there are two fundamental points to take into account:
If the projected pre-sales are not given, the bank runs the risk (again) of having to finance that amount, therefore, before starting with the disbursements, the validation of the pre-sales that generate sufficient income for the assumed amount must be required.
The payment flow to the Bank decreases by the same amount as the income from pre-sales considered in the financing, and although the guarantee for 100% of the property is had, in all the practical cases in recent years, the bank has had to settle for the payment of the remaining percentage to ensure at least the true flow.
It must be considered that there are buyers who have contributed to the company part of the price of the unit they are buying, and that there are probably documents that support them and therefore they could go to the courts of law for the company to return their contributions and establish a lawsuit with the risk of the units in conflict being seized or even worse that the entire project is seized, as has happened in some cases. Therefore, when there is a contribution made by a buyer for the purchase of a unit under guarantee with the Bank, it must be recognized that the value of the residual guarantee has deteriorated by at least that value.
If there is income from pre-sales above what is accepted in the financing structure, these must be contributed to work reducing the approved line by the same amount.
The Safety Coefficient
Just as structural engineers design keeping in mind a safety factor that depends on the area where it will be built: if it is seismic; the type of land, etc., in the case of financing for real estate projects, a guarantee / debt coverage is used as a security factor. It is the slack of guarantees of the project.
The model says that a guarantee / debt coverage equal to 2 is sufficient to be covered against unforeseen (but probable) events. And practice has told us that we were correct. For cases in which the project starts pre-sold and targets mass markets, it is estimated that the previous ratio may drop to 1.5. (For example, PET houses).
It is important to analyze in detail what this guarantee / debt relationship means, to understand some events that have occurred and that will be analyzed later.
The numerator of the safety factor: the Guarantee, is understood as the total value of the sales of the finished project, estimated at the beginning of the project.
There are two crucial points in the previous sentence:
- That the project has to be finished - technical risk and It is the estimated value in the initial evaluation of the project.
It is usual that between the evaluation of the project, its construction and the completion of the sales approximately two years elapse, and in less than that time, we have seen it recently, the economic scenario can radically change.
As mentioned above, when the buyers of the units have advanced funds to the company, theory and experience tells us that the bank will raise the guarantee of the respective unit only with the residual flow associated with that unit, ensuring the flow and not losing the sale. Therefore, when it comes to collateral, it depends on variables that cannot be controlled by the Bank (the market sale value once the project goes on sale) and on controllable variables (the control of sales flows). This will be seen in detail later.
The denominator of our safety factor: debt, is understood as the line approved for the project; stating like this seems like an immutable number and which one should not worry much about. However, here we find the aforementioned Real Estate No Return Point, which once exceeded, any oversight in monitoring will force us to increase our amount of line for the project. Therefore a better definition for the denominator and our safety factor is: Estimated maximum debt once the project is finished. And this is again a variable basically controllable by the Bank.
Therefore we have that our safety factor can be defined as:
Sales flow (*) / maximum debt (*). (*) estimated once the project is finished.
Real Experience
How the Safety Coefficient Was Exceeded
In July 1998, financing was approved for a company with a long and successful real estate trajectory in his city, of good character demonstrated in a long relationship with the respective bank. One of the projects presented was the second and similar stage of a successful project, with a healthy financing structure and another, although it aimed at an exclusive segment, started with 51% sold and also had a good financing structure. Additionally, it was approved to change part of the financing in financial credits of an office project, for guarantee certificates, since there had been a significant sale, which showed interest in that building. In this case, sales were released that made the guarantee / debt ratio tighter,but keeping in mind that the company at that date had successful projects financed by the bank with good guarantees. Although the global risk seemed high, when projecting a flow of debts of the company with the bank, it was appreciated that the peak would be MUF 620, so the maximum indebtedness was limited to this amount.
Situation at the time of approval
With the bank
It had four projects in different stages of progress: two completed with 78% and 91% sold, respectively; and two projects in execution, with sales of 63% both. These indicators showed success in what he was developing.
Additionally, and considering the success noted above, some land financing had been approved, which was paid with the flows to be received and to be sold from the finished buildings or in a high degree of advancement and sales, also with the guarantees of those land.
The global situation at that time was:
Net debt of MUF flows
Therefore, there was a net debt of flows of MUF 215, which was paid with MUF 373 of units to be sold, also having MUF 117 of land as collateral.
New Projects to Finance
Considering the success of the Stage 1 apartment building, 63% progress and 63% sales, the second stage was presented for financing, which consisted of a similar building: 25 floors; of values between UF 3,500 and UF 5,000, which already had a 20% advance and 15% sales to date. The success was based on its good location and the quality of the product.
In conjunction with the above, the development of a building aimed at the high segment was presented for financing: 7 departments with values of UF 8,200 to 16,000, which although it pointed to a very restricted market, it was reported that 3 apartments had committed sales by the MUF 36 value (51% of total sales and 100% of financing requested).
Additionally, the modification of the financing of the office building that had a Line for MUF 143 was requested, but when selling the offices in green to an important company in the region for MUF 87, it requested Gratia Tickets for the same amount. To ensure that these resources were invested in the work, the amount of the line should have been reduced by the same amount, but it was requested to reduce it only by MUF 48 and release the rest - MUF 39 - in exchange for allocating 100% of sales to cancel debt.
Financing Structure
Apartment building Stage 2: for an investment of MUF 366, MUF 230 was requested, that is, 63%.
High-level apartment building: For MUF 59 investment, MUF 35 was requested, that is, 59%.
Office building: By releasing part of the sales of the offices, the Sales / Debt ratio at the end of the building and considering an interest projection would be 1.4. Although this last index was lower than the established policy, the exception was justified on the one hand by the interest shown in the building, having sold 63% of it and the global situation of guarantees and success in its projects.
The maximum guarantee / debt ratio was therefore 1.7 and the guarantee / debt ratio net of flows at 2.2.
In October 1998, the company submitted a report to the bank explaining a need for MUF 98, to cover the cash deficit that would arise, given the drop in sales speed and that it had invested in the development of future projects. However, when analyzing the cash flow presented, contradictions were deduced, since only MUF 47 was detailed in the development of other projects, MUF 13 for general expenses of the company and it was reported leases with purchase option in their projects that were adjusting box. Given this, the bank discussed the issue more deeply with the company.
The result of the foregoing led to the detection, in December 1998, that since the last approval the company did not enter MUF 42 sales product in green, which had a significant reported overcharge and needs for general expenses of UF1,300 / month. A detailed report of balances to be invested, funds to be received, suppliers, etc. was requested. In addition, it was observed that the approved peak restriction had not been met.
The following January, the situation of the company is clearer, and it is summarized as follows:
Greater financing needs to complete the MUF 190 works, these were explained by:
Greater financing needs to complete the MUF 190 works
The company did not contribute the fees, general expenses, project expenses or financial expenses, as stated in the loan filings. He did it with sales, he always did. It did not have adequate solvency at the levels of investment developed and, when demand contracted, the PNRI point of no return had been passed. The bank did not have control of sales flows. So you can guess from what you've read so far what happened when sales stopped. The bank had to finish the works. The slack loss reached, when the first analysis was made, UF 232,000 (UF 42,000 for less sales flow and UF 190,000 for higher financing).
At this point the maximum guarantee / debt ratio had dropped to 1.3 and the guarantee / debt ratio net of flows to 1.4.
With this safety coefficient, greatly reduced, it had to face the crisis of real estate demand and high interest rates, not being able to resist it, which caused a collapse in financing.
How to limit the risks
Variables controllable by the Bank
Previously we saw most of the variables that are critical to maintain the slack designed in the approval are controllable by the Bank, but if the concept of the PNRI, or the “fundamental principle” is not clear, they are not easily controllable and this was demonstrated in practice.
Let's see a little more in detail these variables, which make up our safety factor, and how they are controlled. They will be divided into flow variables (the numerator) and maximum debt (the denominator).
Controllable flow variables
Pre-Sales Income
They can be divided if they occur during the course of the work or after construction is completed. In both cases, the company must send its sales statement on a monthly basis. If there is income from pre-sales during construction, these must be contributed to work, discounting the transfer from the next payment status. If they were not considered in the construction, they must be contributed to work, discounting the turn of the next payment status. If they were not considered in the financing structure, the line must also be lowered by the same amount. If the income from pre-sales occurs after the construction is finished, our control is less but we detect it in the monthly report and we demand it immediately (at least at this stage the work is finished and, therefore, there is less risk).
Exchanges of m2 for Executed Work
Some real estate companies, in order to complete the financing of the projects, agree with the contractors or subcontractors to exchange the price of the subcontract for m2 of our guarantees that will be delivered once the project is completed and received. This is equivalent from the point of view of the bank's control to a cash presale, with which it can go on sale competing with the products that are in guarantee. In calculating the guarantee coverage, this flow must be discounted.
As in the case of income from presales here, although we have the mortgage of the unit given in exchange, the value of our guarantee has deteriorated in the total amount of the exchange.
Related Sales
In certain cases, part of the sales that some real estate companies present are sales to the same partners. This should be analyzed carefully since, firstly, this is not necessarily showing a real estate success of the project and secondly, the degree of enforceability of these promises is quite weak.
Maximum Debt Controllable Variables
In general, the control of these variables occurs month by month during the turns, while the work is progressing. The turn of the financing of a real estate project is not simply the progress of the work. There are a number of other factors that should be taken into account, and that depend on both the initial approval conditions of the loan by the respective committee, and the conditions in force at the time of the transfer, for example: prior contribution from the company, income for accumulated presales, pari passu company, advance granted, detected cost overruns, etc. This implies that those who control the curse of the drafts must have a thorough knowledge of the principles that govern real estate financing.
Incorrect Advance
Interests
In general the interests are borne by the company. In order not to accumulate too much accrued interest, credits must be drawn with maximum terms of ninety days so that at each renewal they demand their payment.
If there are strong interest increases during the financing of the project, the companies that did not have adequate solvency at the committed investment levels will request the bank to capitalize these interests or request the increase of sales flows to pay them, weakening our coverage.
Cost overruns
If during the construction of the work an extra cost appears, not initially considering it, the later the bank detects it, the more difficult it will be to demand that the company contribute it. Especially if the financing is past the real estate point of no return, the risk that the bank will have to provide it will be greater. If there is special care at this point in the review of the monthly progress of the work, it will be possible to detect these types of problems in time.
Other expenses
Other Expenses are understood as the following: payment of municipal permits, calculation and architecture fees, specialties fees, sales and advertising expenses and mainly, which will be dealt with separately, financial expenses.
In general, in a real estate project, the bank finances part or all of the construction cost, leaving the contribution of the land and other expenses to the company. This is because, in addition to the fact that the percentage of the investment that the bank finances coincides with the financing of a percentage of the construction cost, this can be objectively measurable through the verification of the progress of the work, which are broken down by clearly identified items. and valued.
It is difficult to control the disbursement of these "Other Expenses" but there are two ways that can help limit this risk of non-contribution. First of all, it must be verified that the real estate company has adequate solvency at the investment levels presented and especially with the flows to make its contribution. Secondly, a brief detail of the financing of the work up to that moment must be requested from the company together with the progress of the work and the sales sheet.
Advance not returned
Any advance that is granted to a real estate financing implies that the "fundamental principle" that the balance to be drawn from the bank completes the work is being broken.
This is important to take into account in the advance amounts that are granted and in the monthly discount proportional to the advance. If there is a third-party company that builds, the risk is lower, if the real estate company requests a guarantee slip for the amount of the advance.
Pari Passu (proportional contribution of the partner to the progress of the work)
In this case, like the previous one, at the start we know that the principle is being contravened that with the balance to be drawn from the approved line the work is finished. It should be considered that if the PNRI is passed, there is a risk that the bank will end up financing the company's contribution. In these cases, it must be analyzed whether, considering that the bank has to finance this contribution, the financial structure is still reasonable. In these cases, it must be carefully analyzed if the company has the solvency and the cash flows to make this contribution.
Withholdings on Contractors
In some cases, the real estate companies withhold a percentage amount from the construction companies as a guarantee of compliance. If the bank does not take the precaution of in turn deducting the same amount from the transfer, there is a risk that once the construction is completed and the line approved for this purpose has been completely drawn, the real estate company still has a debt with the construction company, which can affect the final reception of the project.
Providers
There is the possibility that the company finances part of the work with the supplier term, and that as in the case of withholdings to contractors, the work can be completed having the entire line rotated and the real estate company still have debts with suppliers. This can be controlled at each stage of progress, requiring that together with the progress of the work and the project sales sheet, the company inform us of the financing of the work up to that moment.
Clearance Losses
Here we will see how the safety factor or slack of the project is affected by a change in both the controllable and non-controllable variables by the Bank.
If at the end of the project we face that we have a 30% lower flow for the payment of credits for: Pre-sales not entered, price reductions, exchanges not considered, and additionally we have a 30% greater financing due to: Interest not contemplated, construction cost overruns, other non-construction expenses contributed by the company, money order greater than advance, advance payment not returned, pari passu company not fulfilled, withholdings to contractors spent, suppliers not paid. The designed slack is completely lost, the flow of sales becomes equal to the maximum debt.
The lower payment flow combined with the higher obligatory financing are strengthened and accelerated the loss of slack. It is also clear that before the final reception of the project, the numerator is always at the most (the flow) and the denominator is at the least (the final debt).
In our recent experience, the above occurred in reality and in some cases the ratio: Sales Flow / Maximum Debt, became even less than 1.
Monitoring
As we have seen, although the design or the gaps taken in the financing model are correct, maintaining these gaps until payment of the loan is not an easy task. And this is because there are a series of controllable variables - we have identified at least ten - that if you do not have clear concepts of the principles of real estate financing, they can easily be uncontrolled.
This is not easy to understand for those who make decisions about organizing real estate projects. They know very well and have been successful in financing and managing the loans of the rest of the non-real estate companies, but they do not know in detail the workload involved in managing the line of credit to finance a real estate project.
The organization
The exhaustive work of the real estate executive does not end with the approval of the line of credit for the real estate project, but it really begins there. It is required to mortgage the land, review pre-sales, turn against work progress, discount pre-sales, receive payments for each unit and concept (savings, subsidy, mortgage), analyze the guarantees of the finished units, comparing what received with what was approved, etc..
A project can have hundreds of units for which all the information of the income received and its detail must be saved.
There are projects of few and very expensive units or of many units and low in price, etc.
A detailed analysis tells us that the measurement of the client portfolio of a real estate executive should be based mainly on the number of units that he is financing simultaneously. This is because it is not the same, in terms of workload, to manage a project of ten houses of UF 10,000 than one hundred houses of UF 1,000, even though it may be the same level of placements (UF 100,000), the same number of clients (one) and the same number of projects (one).
On the other hand, for the same number of units, the client who has more projects will require more work for the executive. And also for the same number of units financing, the executive who has more clients will have more work.
Therefore, to define which is the optimal portfolio of a real estate executive, and to compare equivalent real estate portfolios between executives, the following parameters must be taken into account: number of units financing, number of projects, number of clients and amount of placement. Being the number of units financing the parameter that must have the highest weighting.
Given that construction companies (contractors) are managed in the portfolio of any real estate executive, this effect must be taken into account. These types of companies in general can be measured by the classical parameters.
To endorse the money orders and rises, there must be trained personnel in the controlling units with knowledge of the basic principles of financing real estate projects.
The communication
Many of the problems that occurred with the crisis in the real estate sector were due to the banks not communicating correctly to the real estate companies what the procedures are for handling this type of project. In order to limit this, the guidelines on which the bank operates in this sector and the fundamentals behind this procedure must be clearly explained before the first turn.
Final conclusion
The contraction that the Chilean economy experienced between October 1998 and August 1999 has so far had repercussions in the construction and real estate sectors.
Increased sales of homes, offices or the execution of civil works entail a generalized reactivation due to the greater consumption of construction materials, hiring of labor and higher tax collection for the fiscal coffers, in a kind of multiplier effect. Based on the tax incentive decreed in 1999, the real estate and construction sector resumed investment projects that are currently on the market and in a context where the recovery in domestic demand that was projected is not being fulfilled.
At this time the market conditions are optimal to buy, the interest rate is at historically low levels, therefore, the rates for mortgage loans are low; inflation is under control, so there should be no apprehensions and, in addition, the existing housing supply is very good.
Given the above, banks have begun to increase their placements in this type of project, but based on the experiences of the crisis, they have had to protect and generate special units that help minimize and limit the risks associated with this type of investment.
As a summary, we can point out that the identification of associated risks, compliance with the fundamental principles and the use of tools in the financing of real estate projects will help to maximize the profits of financial entities.
Finally, it can be concluded that the real estate sector is highly profitable for financial institutions, but since the paradox is fulfilled that "The higher the Profitability, the greater the Risk", the necessary tools and provisions must be had to manage these investments when it returns. grow this sector at pre-crisis rates.
Annexes
Appendix 1
Banco Santiago Real Estate Credit Evaluation
objective
With the aim of unifying criteria of: evaluation; presentation to committee; and monitoring of real estate projects, below are a series of recommendations that should be considered when analyzing and managing this type of credit:
The minimum information that must be requested and analyzed when dealing with a real estate project is detailed below.
to. Partners
a.1 Character
The Character is considered necessary but not sufficient for the granting of the credit. Clients must have a good character, which must be described for every client -particularly if it is new-. The commercial bulletins should always be consulted and their result indicated in the evaluation.
a.2 Experience
Verify experience of having previously developed similar projects, or if you are consulting with personnel who meet this requirement. In the latter case, their presence must be conditioned throughout the project. You must indicate the most relevant works in which you have participated.
a.3 Solvency
Analyze the financial situation of the partners: State of Situation, if they are natural persons; balances, works in progress and others without are companies.
b. Real estate
b.1 Works in Progress
Request a detail of all the works that are being executed where they are included: project name, project type, total sales value, number of units, average unit value, investment value,% progress,% sold, current debt, maximum debt, entered by sales, funds receivable from sales and balance to be sold.
b.2 Balances
Have at least the last three balance sheets which must be contrasted with the works in progress analyzed above and the debt with the SBIF
b.3 Debt Superintendency of Banks and Financial Institutions -SBIF
Analyze the evolution and contrast with the balance and works in progress.
c. Market analysis
In general, real estate managers face a price and the speed of sale (which determines profitability) at that price depends on the projects that are being developed simultaneously with their own and, mainly on the market's ability to periodically absorb a quantity of new units.
The foregoing means that it is necessary to request from the company a market study related to the project being analyzed or, failing that, make an analysis of its own or through an authorized appraiser.
d. Draft
Before approval, all real estate projects must be analyzed by an authorized appraiser of the Bank or by the Construction Credit Evaluation Area. This may be exempted by the Real Estate Credit Manager who will take into consideration factors such as: Company with experience in similar projects in contiguous lands, etc. See exceptional procedure page 7, item 1.9.3.
This analysis should cover at least the following aspects:
d.1 Location
Clear description, accompanied by a plan of the sector where the project is indicated.
d.2 Description
Building type, typology, surfaces, warehouses, parking lots, etc.
d.3 Architecture
The decision to buy a home or office depends, among other variables, on the type of property (need, comfort and culture) and its architectural characteristics (beauty). This is where the importance of the architect's experience is born and that he achieves an adequate distribution of spaces, degree of finishes and harmony in the facade, with respect to the defined market. It is necessary to know the architect and his experience in developing similar projects.
d.4 Cost Analysis
In general, the costs of any building project can be broken down into: Land, Construction and Other Expenses.
- Land: ideally there should be an appraisal, this should consider, among others, aspects such as location and legal regulations. Construction: regarding its specifications, a judgment should be made on the value per total built m2 as per useful m2. Other expenses: must analyze individually as well as their total proportion in the project investment
d.5 Sales price analysis
Both at the unit level and its global value. In the case of branches, it must always be indicated if the value is with or without VAT.
d.6 Specific Market Appreciation
Analyze the projects that are currently being executed in the area with advance sales data and prices.
d.7 General Appreciation
Comment that summarizes the previous points with a critical judgment of the project, as well as additional antecedents not previously treated such as legal regulations, water endowment, unconsolidated neighborhoods, special developments, etc.
d.8 Construction period
Analyze the deadline and have a judgment on it.
d.9 Construction company
The construction company must be qualified by the Bank and ideally it must be independent from the real estate company, with a lump sum contract and deliver Guarantee Certificates that guarantee its obligations.
d.10 Construction Permit
Verify that the project is approved and with its consequent construction permit.
The project must subsequently be summarized in 1 sheet where the quantitative information of the points mentioned above is emptied. This is done in an ad-hoc form called the Project Information Form - FIP-.
and. Financing Structure
The financing structure is fundamental for the evaluation of the profitability of the investor, the more he goes into debt to carry out the project, the higher the profitability he will obtain with respect to his investment. However, on the other hand, the greater the debt, the greater the risk of the project.
From the Bank's point of view, the higher the project's indebtedness, the less room there is for a quick exit in the event of a deterioration in the sales situation or other problems that affect the general development of the project during or after construction. finished.
In general, when a real estate project is financed, a percentage of this is always financed - no more than 65% of the total investment - and such that the ratio (sale price / maximum debt) is greater than or equal to 2 times. The Bank's financing and the form of remittance must be such that it always ensures that the Bank's contribution completes the project completely. In the event that there is an advance, as indicated below, the advance must be deducted from the calculation in its unreturned amount.
Given that every building project can be broken down into: Land, Construction and Other Expenses, in general it can be assumed that the Bank is financing a percentage of the construction.
Additionally, it is established that the Bank's disbursements must be in accordance with the progress of the work, in order to ensure that they are effectively invested in it.
There are some cases in which an Advance of the construction cost is requested. This must be returned proportional to the progress of the work and may not exceed 20% of the construction cost with a cap of 50% of the value of the land.
The remaining percentage of the construction must be contributed first by the company before the Bank begins its financing.
Appendix 2
Monitoring Real Estate Loans
a) Form of disbursement
The company must always contribute its percentage in construction first, since if the Bank is the first to contribute on site and subsequently the company cannot or does not want to contribute more on site, the Bank's negotiating capacity is practically nil and it may be forced to complete the work, ending the project with a more unfavorable financing structure than that initially accepted as normal risk.
Always, including the cases in which the Bank finances 100% of the construction, in each Bank disbursement it must be verified that the balance to be drawn from the approved loan is greater than or equal to the balance to be invested to finish the work. If there is an advance, this must be deducted from the calculation, considering its return proportional to the progress of the work
Before the first bank transfer, the existence of the works construction permit must be verified. Any exception to this - for a period not exceeding three months and paying an amount that does not exceed a certain percentage of the value of the land - must be explicitly given by the committee that approves the operation, requiring special monitoring in this case. This is essential since it may happen that after disbursing part or all of the approved Line, the work is completed and the aforementioned permission is not obtained, so the guarantee at that time is worth zero, or only the land has value, or goes through high demolition costs.
Before any turnaround, the progress of the work must be verified by an authorized appraiser or by the Construction Credit Evaluation Area.
b) Green Sales
One way to anticipate a certain degree of success of a real estate project is the level of green sales (sales before the work is received by the municipality). This is achieved through efficient advertising and marketing management with pilot houses, etc.
The sale in green can only be considered as such when it implies a significant degree of commitment and strong relative exit barriers (fines, accepted letters, etc.).
Bank financing must be adjusted to the evolution of green sales in such a way as to reduce the approved margin to the extent that flows for this concept enter. Despite the fact that the project can be very successful and have a lot of green sales, it is required that the income from green sales enter the work and not be diverted to other businesses that we do not know. In the extreme it can happen that an exceptionally successful project is sold completely in the green and those funds come in and the company uses them in another business and this one fails. If the Bank did not take the precaution of reducing the approved line, the work is finished with the line fully completed and the company may not have the funds to pay and request the increases. Although the Bank has the full guarantee,Buyers do not differentiate to whom they passed their money and collectively demand that the Bank raise the guarantees of "their" already canceled homes, the Bank facing a social problem.
It will depend on the type and price level of each project, the way to validate the green sales. Namely, some guidelines are given as an example:
| Rank of | Hitch formula | Hitch formula | |
| Households | Prices | Habitual | Validation |
| PET | UF300 - UF400 | Ballot G. Advance of Subsidies | Request for the BG SERVIU Advance Subsidies |
| Subsidy | UF500-UF1.000 | Subsidies endorsed to the construction company | Grant endorsement review> 50% |
| Market | UF1,000-UF2,000 | -Between 5% and 10% foot paid
-15% or more documented during construction |
Review> 50%.
Validate promise of sale, fines, exit barriers. Check commercial reports from buyers. |
| Market | > UF2,000 | -Between 5% and 10% foot paid
-15% or more documented during construction |
Check that you are not an investor (only considered 1 time)
Checking which related buyers pay and is not against project success. Analyze exchanges or swaps. |
Annex 3
Credit Justification
All credit applications related to real estate projects must contain at least the following points in the Credit Justification:
Objective: Indicate objective of the request
General Background:
Partners: percentage of participation, experience and financial situation, information on commercial bulletin.
Company: Experience, current works in progress.
Project Background
Description: Location, number of floors, number of departments or offices, parking lots, warehouses, etc.
Investment Detail: a table must be presented with:
| m2 | UF / m2 | Total | %/Investment | ||
| I | INVESTMENT | ||||
| Ground | % | ||||
| Building | |||||
| Edification | |||||
| Urbanization | |||||
| Total construction | % | ||||
| Other expenses | |||||
| Project fees | |||||
| Contributions rights and permissions | |||||
| Selling expenses | |||||
| General expenses | |||||
| Financial cost | |||||
| Total other expenses | % | ||||
| TOTAL INVESTMENT | 100% | ||||
| II | INCOME FROM SALE | ||||
| Apartments, Offices or Houses | |||||
| Parking lot | |||||
| Wineries | |||||
| TOTAL SALES | |||||
| III | PROFIT AND PROFITABILITY | ||||
| Utility | |||||
| Return on sales | |||||
| on investment |
Market analysis
Regarding the Macro and Micro zone where the project is located.
Financing Structure
Present a table with the following information:
| Business | Green Sales | Bank | Total | % | |
| (MUF) | (MUF) | (MUF) | (MUF) | ||
| Ground | |||||
| Building | |||||
| Other expenses | |||||
| INVESTMENT |
Exit price scheme and sale relation to list price / Bank debt
The starting price considers the value at which the units could be sold to pay the loan requested from the Bank in case the project is not sold at the value established by the company at the beginning. For this calculation, at least 1 year of interest must be assumed at the peak of debt and at the maximum conventional rate.
Present a table with the following information:
| Value | Unit | ||
| one | Bank financing | (Uf) | |
| two | Interests | (Uf) | |
| 3 | Total Debt (1 + 2) | (Uf) | |
| 4 | No. units | No. | |
| 5 | Starting price | UF / Unit |
Another index that should be shown is the ratio of the total list value, once the units are finished, with respect to the maximum debt requested from the Bank:
Value ready once the project / Debt approved
Projects in Execution
Present a table with at least the following information:
| Draft | Sale | Investment | Debt | No. | Value | % | % | Sales | Sold | Sold | Balance |
| total | total | maximum | units | average | Advance | sold | carried out | received | x receive | x sell | |
This should be clearly separated between Current Projects and Proposed Project.
Financial Background of the Company
Present a table with the following information:
| FIGURES IN M $ | twenty__ | twenty__ | twenty__ | twenty__ |
| SALES | ||||
| UT. OPERATIONAL | ||||
| UT. NET | ||||
| WORKING CAPITAL | ||||
| CURRENT REASON | ||||
| LEVERAGE | ||||
| FINANCIAL ASSETS | ||||
| LONG-TERM LIABILITIES | ||||
| HERITAGE | ||||
| SBIF DEBT |
Project evaluation
The evaluation of the project made by the appraiser or the Construction Credits Evaluation Area must be attached as an annex, which must include the Project Information Form -FIP-.
CONTRACTING COMPANIES
In the case of contractor companies, the following must be included:
Brief Description of the Contract
Description:
Amount:
Principal:
Term:
Contract Type:
Readjustments:
Way to pay:
Works in progress
List of works in progress with corresponding progress and indicate the rate of S aldo of O bras by E xecute on equity (SOE / Pat).
Arrival to Proposal.
List of companies that submitted their offer.
Bibliography
- Construction Companies Financing Manual - Banco Santiago, year 2001. Construction and Real Estate Sector Report - Banco Santiago, year 2001. Personal experience as Risk Analyst of the Real Estate and Construction Risk Division of Banco Santiago, years 1999 to 2001.
