Australia’s construction industry continues to exhibit relatively higher levels of risk, with extended payment delays, disclosures of outstanding tax debt, increased credit shopping behaviours (approaching multiple funders), and a rising number of construction insolvencies. On top of these conditions, incidents of non-compliant building works have dented confidence in construction by investors, funders, and the broader market.

The challenge is even more pronounced in an environment where a significant portion of tomorrow's housing supply is expected to come from urban infill and medium-rise apartments, a segment sometimes characterised as comprising more thinly capitalised special purpose vehicles (SPVs) or constructors that have experienced significant profitability erosion with lower net operating cash flow and higher levels of creditor exposure. 

With projects frequently delivered through a cascaded delivery model, the reliability and resilience of the project team - and consequently, the quality of the built asset - is only as strong as the weakest link. The interconnected nature of project teams exposes builders to contagion risks, wherein financial distress or insolvency of one partner can cascade through the entire project ecosystem. Investors and funders are well aware of these counterparty risks.

Complexities of development financing

Development financing is often complex, with longer timeframes and inherent risks requiring careful navigation and strategic planning. Many residential developments rely on third-party funding, with debt and capital market funding commonly used for land purchase and/or construction works. Funds are typically tied up until the development is sold, and longer development times often necessitate extending longer credit/investment tenure or refinancing loans beyond the initial term. While interest accrues throughout the loan’s life, the debt is typically repaid upon project completion. Several factors influence funding costs, but foremost is the level of credit risk and the extent to which an investor/funder is willing to accept that risk. Simply put, credit risk refers to the risk of loss that an investor/funder faces if the builder fails to honour the repayment of principal and interest on the funds provided.

How funders evaluate funding proposals

According to the Stamford Capital 2024 Real Estate Debt Capital Markets Survey, 82% of lender respondents have increased their due diligence due to the rise in construction insolvencies. While investors/funders have different approaches and risk tolerance, they all assess relatively similar factors and criteria when evaluating the credit risk of both the builder and the project. While this invariably starts with the development itself, encompassing project viability and financial feasibility, several other factors come into play. These include:

  1. Capability: Assessing the builder’s capability involves reviewing their track record, past projects, key resources, design and delivery assurance, and governance practices.

  2. Character: Considering the people behind the business, including the principals and development team, reviewing their experience and background.

  3. Capacity: Evaluating the capacity to honour commitments, scrutinising the project plan, budget, construction schedule, risks, pre-settlement deposits, debt serviceability and projected cash flows.

  4. Capital: Investigating the committed capital and financial resources available to the builder, including their net worth, equity position, borrowing capacity, collateral and other funding sources.

  5. Conduct: Reviewing the project and practitioner compliance with relevant laws and regulations, examining past conduct and their willingness to honour obligations and commitments.

  6. Counterparty risk: Analysing the builder’s related parties, inter-company transactions and balances, and key trading partners to assess counterparty and contagion risk.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

Investors/funders also evaluate the deal structure, conditions and collateral (or assets) that can be pledged as security for the loan, along with market conditions, development trends, and their overall sector exposure/appetite. They employ various measures to assess risk, including debt coverage and serviceability metrics, loan-to-value and loan-to-cost ratios, and consider the overall discounted rate of return. 

If the risk is deemed high, the lender may refuse to lend or impose a debt ceiling (LVR/LCR limits) and/or debt & reporting covenants. This might necessitate seeking alternative forms of funding, which may be considerably more expensive with a higher cost of capital. 

Investors and funders typically use their own in-house credit risk assessment processes, often supported by credit bureaus, market intelligence, and ratings from licensed, regulated ratings agencies. Credit ratings assess the borrower’s capability, capacity and willingness to honour commitments and can only be provided by licensed ratings agencies. This market is regulated to uphold the quality, integrity and independence of rating services, with only a few licensed agencies in Australia, including Equifax, S&P, Moody's and Fitch.

Some suggestions for inclusions in a compelling funding proposal

With a deep understanding of evaluation criteria, builders can take steps to tailor their funding proposals to address key funder concerns and mitigate perceived risks. Incorporating the following elements into proposals will help builders communicate the value and potential of their projects: 

  • Project Overview: Provide a comprehensive overview of the project and what will be developed, including planning permissions, environmental regulations and community benefits.

  • Market Analysis: Offer market insights to assess demand and viability, including local market data, marketing strategies, and buyer insights (see “Leverage iCIRT ratings to build confidence” below).

  • Project Timeline: Detail key milestones to clarify the development phases and duration, from pre-development activities to construction and handover.

  • Financial Projections: Document the key assumptions and evidence in support of comprehensive financial projections, including cost estimates, contingency plans, discounted cash flow analysis and project profitability.

  • Funding Request: Clearly outline the amount of debt and/or investment required, the proposed use & timing of funds, with supporting references to market valuations (in support of loan-to-value ratios), and any proposed security or collateral. 

  • Projects and Proven Track Record: Showcase past projects and development experience to demonstrate capabilities and a proven track record in delivering similar projects successfully.

  • Development Team: Highlight the credentials and experience of the key persons behind the business, including the property development team. Responsible lending practices require funders to complete Know Your Client (KYC) activities, including identity verification and background checks such as anti-money laundering, counter-terrorism financing, politically exposed persons and/or sanctions. 

  • Management Structure and Resources: Detail operational resources and governance practices for reliable project oversight and management, ensuring clarity on the organisational structure, operational resources, and governance protocols.

  • Business Structure: Showcase the corporate structure, related parties, and group stability to support a more holistic assessment, providing transparency around corporate connections, equity, and capital adequacy.

  • Showcasing Resilience: Demonstrate risk management and mitigation strategies, highlighting adaptive management practices and contingency plans in response to cost overruns or project delays.

  • Reliable Partners: Align with reputable business partners to build confidence in the broader build team, evidencing due diligence processes, selection practices, and third-party oversight, mitigating contagion risk and supporting all project stakeholders with improved project assurance.

Leverage iCIRT ratings to build confidence

A powerful tool to help bolster investor and funder confidence is the Independent Construction Industry Ratings Tool, iCIRT from Equifax. By obtaining an iCIRT rating, builders could gain valuable insights into their business’ strengths and rating constraints, enabling potential areas of concern to be proactively and clearly addressed to optimise investor appeal. A strong iCIRT rating helps validate the builder's credibility and signals to investors and funders that the financial viability, robust partnerships and strong governance of a business will help it maintain resilience in the face of project delays and industry challenges.

iCIRT provides up to a five gold star rating outcome for builders, developers, technical services providers and consultants. Businesses undergo a performance-based assessment using data, interviews and evidence to obtain a rating, with 150 key attributes endorsed by the public and private sector in determining the trustworthiness (or level of risk) of construction professionals in the design, development and delivery of reliable and trustworthy built assets. 

Importantly, the process of choosing the most relevant attributes included valuable input from funders and lenders to ensure these rating insights would support their due diligence and assist in providing an expanded line-of-sight across builders and their delivery chains.

Funding benefits of trustworthy credentials

More than a third of NSW construction lenders surveyed now incorporate iCIRT ratings into their decision-making, according to Stamford Capital’s 2024 Real Estate Debt Capital Markets Survey. A further 19% plan to follow suit in the next six months and 43% have rejected loan applications with no ratings or poor iCIRT ratings.

Stamford Capital Group Executive Chairman, Domenic Lo Surdo notes: "iCIRT has had a huge impact. What we've seen with funders and iCIRT is an increased appetite to lend. Where a developer and/or a contract builder has an iCIRT rating the willingness of the market to look at that deal has improved, lifting the availability of capital, and invariably driving the price down."

This heightened level of trust can help translate into tangible benefits, facilitating easier identification of trustworthy building professionals by homeowners, industry stakeholders and regulators alike. iCIRT ratings can enhance buyer and agent confidence in successful pre-sales, with research revealing that 81% of prospective buyers aware of iCIRT have a positive perception of the construction industry. 

An iCIRT rating can be a crucial reference point and data-driven evidence for insurers, financiers and regulators seeking to ascertain a company’s stability, capability and credibility. 

Acting NSW Building Commissioner, Matt Press explains why iCIRT has been critical to lifting construction capability and supporting the industry in moving forward: “As a regulator we’ve leaned hard into data and assessing risk and that now guides all of our regulatory activities determining which people or projects that we’re going to focus our attention. 

And the iCIRT ratings is the public facing version of that approach, empowering the industry with information on its own risk profile, and giving it somewhere to aspire to, in terms of how they might want to improve and perform better. We’re seeing that significantly change behavior across the industry but also improved consumer confidence because they can see the industry investing in being a better version of itself.”

Reach out to our iCIRT team to discover how ratings can bolster investor, funder, insurer and market confidence. 

4 Equifax quarterly commercial insights, Q3 2024

5 Construction Insolvencies Hit Decade High, AICM Aug 2024 

6 Stamford Capital surveyed over 100 lenders in April 2024 for their perspectives on the real estate debt capital market

Disclaimer: The information provided in this article is intended for informational purposes only and should not be construed as financial advice. Readers are strongly advised to seek independent professional advice tailored to their specific circumstances and requirements.