|
| Development
Preference Shares - an alternative to development risk |
|
| It appears
to be the latest trend to involve investors in development of projects,
in order to gain greater return for the investor. Development does
involve some level of risk. When Professional developers look at potential
returns they generally expect some level of variance to the returns suggested
at the outset due to building delays, expenses being over budget and a
lack of sales of the final product which can add to holding costs. |
|
| As a way to
limit these risks for those funding projects developers in Australia have
introduced “development preference shares” as a way of moving an investor
into the position of financing the project rather than being a fellow developer. |
|
| The way
a development preference share works is as follows: |
|
| 1).
An issuer raises funds by issuing the development preference shares to
the investor the shares offer a fixed rate of return and maturity date
– say 18% reflective of normal costs for this type of funding and 24 months. |
|
|
|
|
|
| 2).
The
interest is paid monthly as it would be for normal financing. The attraction
to the developer is the break up of interest into lower monthly commitments
say 8% P.A, then a lump sum payment upon construction completion or the
term of the preference shares whichever is sooner. This amount is usually
equivalent to 10% P.A. The developers would normally being the full 18%
P.A. paid monthly which affects cash flow. |
|
| 3). The
shares are secured by a registered second mortgage held by a trustee on
behalf of the investors over the assets of the developer including land.
The construction financier holds a registered first mortgage when they
become involved, hence the shift to a second mortgage. |
|
| 4). The
money is usually only lent to developers with solid projects, due to the
restrictions of the loan. Often preconditions must be met before the funds
from the issue are released by the trustee such as:o a formal offer to
finance the construction, o a predefined level of sales that covers the
construction finance, o development approval from local and state authorities,
o and a fixed price construction contract. |
|
| 5). The
exit strategy is generally the sale of the project often within the term
of the development preference shares or the term of shares say 24 months. |
|
| Developers
affected by delays have no option but to pay out the development share
holders at the preset maturity date. If they have not sold they can generally
refinance or may take up the funds of a new issue. |
|
| The payments
from the shares are not seen as dividends but interest. For non-residents
these payments are subject to a 10% withholding tax on the amount paid
, say 1.8% on the amounts used above. This withholding tax used as a tax
credit when declaring the income in your own country. |
|
| As you can
see this type of investment involves you in development of property without
necessarily exposing you to all the pitfalls of development. |
|
|
