KEY POINTS:
Grimmer days are in store for the property development sector as mezzanine financiers who back high-risk projects hit harder times.
Economic experts, fund managers, property investors and developers are predicting a much tougher road ahead because of the credit squeeze and the collapse of influential real estate development
financiers like Bridgecorp.
Developers could now struggle to get funds and traditional bank credit lines are too expensive to allow many high-risk developments to fly.
End result? Fewer new buildings, a less robust development community, fewer construction sites and less people working in the sector.
The business is huge: applications for $1 billion-plus of building work alone cross Auckland City's desk annually. But with Bridgecorp and Property Finance Group gone, speculation is rife about who might go next.
Mezzanine debt has been crucial to big projects, with trading banks unwilling to loan more than about 60 per cent of a project's cost. Property pre-sales help developers get a financial top-up, but most developers now reach for their mezzanine funder before they announce deals are goers.
For example, a developer trying to get $100 million funding on a major project might raise $60 million from a trading bank, $30 million from a mezzanine funder and pull in the remaining $10 million from pre-selling a portion of the finished development, allowing full funding of the deal.
If the development fails, Inland Revenue is usually first in line for payment, followed by the trading bank with the prime or senior debt, then the mezzanine financier, whose debt is subordinated or second-ranking to other parties.
Mezzanine financiers pick up the most risky portion of development costs and usually syndicate this debt by issuing bonds or debentures to retail investors - the very sector hit by the latest collapses. The term mezzanine refers to short-term mortgage-secured finance, subject to often punitive interest rates.
Things can easily go wrong.
Investors who pour money into the mezzanine companies are already showing nervousness. Kerry Finnigan, chief executive of Strategic Finance, said instead of getting capital inflows of $3 million a week, his firm was getting $1 million a week now. And Strategic, owned by Australia's Allco, has had particularly good times lately, announcing a $30 million record after-tax net profit on August 21.
Hanover Group also has a big stake in property developments, funding work at Matarangi in the Coromandel, Clearwater resort in Christchurch and resort development work at Queenstown.
St Laurence is another heavy-weight lender, providing millions in development capital for work at Albany and the Mt Wellington quarry as well as owning the management of NZX-listed National Property Trust.
Most of the finance companies have property exposures, including Dominion Finance, Dorchester Finance, Mascot Finance, Orange Finance, Rifleman Finance, Lombard Finance & Investments, MFS Pacific Finance and Capital + Merchant Finance.
But some big real estate investors are worried. Take AMP, which has a massive exposure to the property sector, both via NZX listed and unlisted vehicles, owning properties worth many billions of dollars.
Anthony Beverley, head of acquisitions and investments at AMP Capital Investors, warned about highly-geared projects by developers at the sharp end of the sector.
A tightened supply of subordinated debt and particularly mezzanine finance, combined with the increased cost of that money was likely to hurt developers that traditionally relied on this type of debt, he said.
This is a substantial portion coming from finance companies.
"On this basis, the issues currently faced by this sector will have an impact on property development, particularly on riskier projects with high gearing," he said.
But he said AMP used more traditional sources of credit than mezzanine funders and would be fine.
"All the AMP property investment funds in New Zealand - including AMP NZ Office Trust, Property For Industry and AMP Property Portfolio - fund property development and construction projects with a mixture of investor equity and senior bank debt sourced from the major corporate banks," he said, adding the funds also have conservative debt management and hedging mechanisms.
"Our core property investment funds typically maintain low gearing levels and strong credit positions with the major trading banks and in doing so, are able to source and secure senior bank debt at extremely competitive rates."
Goldman Sachs JB Were economist Shamubeel Eaqub expects the crisis to tip over some large development projects.
He is anticipating a general slowdown of development as the easy supply of money dries up but warns to be aware of the difference between the different financiers.
"If finance company troubles worsen, there will be more stringent lending practices and some developments may fail. Note that this may be specific to low quality developments.
"Following a prolonged expansion phase in the construction sector, this may serve to create a pause. We envisage investment in the sector to moderate over the coming 12 months but do not anticipate a crash. Instead we are looking for consolidation and more realistic activity levels to resume.
"The role of these financiers has been generally most prominent in higher risk projects, which banks are usually unwilling to fund."
He is not expecting more NZX listings, except for the best quality companies. Many property developers would not be up to the standard required by NZX to list, he reckons.
"The level of disclosure required by equity investors would expose many of these companies as high risk. Interestingly, if investors had known the risk of many of the products they were investing in, then few would have exposure to them.
"Financial illiteracy, poorly governed financial advisers and improperly priced financing have culminated in the current mess," he said.
Simon Botherway, of institutional investor Brook Asset Management, is worried about how much money the finance companies have, saying although these funders have an important part to play in the economy, many are under-capitalised.
"As well, they have a significant and dangerous mismatch between asset and liability duration - funded short and lent long. This is the source of most systemic financial collapse such as the savings and loan crisis in the United States which incidentally was the subject of a massive Federal bailout.
"Finance companies have tended to make money by a mispricing of risk - an arbitrage of sorts. Depositors have no idea of the type of risks they are taking or the interest rate they should be receiving for taking that risk.
"It appears there is now a 'run' on the sector as confidence has evaporated. This is a very dangerous development and threatens to engulf even the better companies in the sector. These finance companies will need to seek equity capital - they are typically undercapitalised in any event at any price," Botherway said.
Rob Lang, executive manager of the $1 billion-plus AMP NZ Office Trust, said developers should be very worried.
"I suspect that it has fairly meaningful implications as most developers source their funding through finance companies.
"For most developers, the availability of finance will either dry up - particularly for higher risk/lower quality development proposals - or become very expensive thereby destroying the development economics or become very selective.
"Developers usually go to finance companies because the mainstream lenders won't lend them money," Lang said.
Angus McNaughton, head of Kiwi Income Property Trust, said his trust did not borrow from finance companies.
Kiwi is understood to have sourced much of its funds for Sylvia Park from Westpac.
"We aren't involved with finance companies," McNaughton said.
Rick Martin, head of developer Cornerstone Group, which is finishing its 30-level Sentinel apartment tower in Takapuna, is also concerned about the sector's direction and funding sources.
"How serious this is is up to the developer and whether or not they're in default. If they are not in default, then there's not a problem, even if their bank's gone under.
"The biggest question is who's next?"
We built this city
Without mezzanine financiers, these projects would not have been viable:
* Princes Wharf, downtown Auckland, a $300 million project funded partly by Strategic Finance.
* Residences, a 38-level $100 million Fort St apartment block, funded by Bridgecorp.
* Viaduct Basin hotels, apartments and restaurants were funded by mezzanine debt, partly from Strategic.
* $500 million Albany basin redevelopment (about to start) funded by funders St Laurence and developers Symphony.
