The great funding crunch: Developers create third-tier deposit-taking funds

Former Prime Minister and ANZ NZ chairman Sir John Key is doing it and so are many housing developers – raising money directly from investors.

A big lending squeeze is threatening new property projects at a time when New Zealand needs more housing, so this week’s launch of Stonewood Key Capital – a housebuilder that aims to raise $100 million within 18 months – marks a sea change.

Building is running at a record-breaking pace, with consents granted for nearly 50,000 homes last year. Developers have never been busier and Stats NZ said in December that all up, $7.2b of building work was on during the September quarter, an increase of 5 per cent on the previous year.

But at the same time, house-builders are struggling to get money.

So they’re turning to what are known as “qualified” or “wholesale” investors in a new trend.

The most bullish example is the $100m fund announced on Tuesday by the Chow brothers, with Key and his son Max.

James Kellow of NZ Mortgages & Securities, which has $370m loaned to the building sector, says some Chinese funding for construction has become harder to get lately, although the big banks’ appetite hasn’t changed much.

Trading banks are still loaning 70-75 per cent of housing projects’ funds, says Kellow, “but we’ve had complaints from borrowers saying it’s difficult trying to get funding. But some of the Chinese banks have reduced their credit positions in New Zealand. That may be part of the tightening of credit. Primarily it’s second-tier lenders who expanded their balance sheets rapidly last year and the year before.”

With few deposit-taking finance companies surviving in the wake of the global financial crisis, going direct to investors is one method he is noticing more. Before Tuesday’s announcement of the Key/Chow deal, he estimated the value of that new third-tier borrowing was about $200m.

Matthew Horncastle, managing director of developer Williams Corporation, says: “It’s got a lot harder to get money in the last six months.”

Lawyer Joanna Pidgeon, a specialist in property law, also says funding is tight.

“Banking policy is making it difficult for buyers, particularly first-home buyers,” she says. “The downstream effect of this is that developers are unable to get pre-sales to get building projects started, even though there may be record consents, which then means fewer houses built, prices remain high, fewer homes available to rent or buy.

“I know that a lot of developers are struggling at the moment to get projects off the ground.”

The NZX is one source of funds, but only for larger-scale businesses.

Winton Land raised $350m on the sharemarket at the end of last year, with Macquarie Group buying $200m of shares in the company, no doubt because Winton founder Chris Meehan – born in the Southland town – has a solid track record, many sites and the expertise to turn those into cash-generating developments.

More typically, trading banks provide capital for property investment and development and mezzanine funders top that up, often taking a riskier portion of the mortgage, with subsequent protections built in for themselves in the event of non-repayment.

Non-listed entities like the new MTK (Max Timothy Key) Capital are also in the market for investor funds – in this case for a 13-home Auckland residential project. More about how Key will hopes to achieve that and how much he needs will be out soon.

Capital-raising by listed entities has been another huge source of funds lately, with billions raised for expansions. In some cases, companies such as SkyCity Entertainment Group have had ask for debt waivers from their lenders, as they seek leniency in tough Covid times.

But for years, when it comes to obtaining funding from non-bank sources for properties, the buzzword has been syndication – raising money from a group of investors to buy an existing property or a development project. The minimum investment is often $50,000-plus and investors are promised a share of the returns generated by the property.

This remains a popular method and unlike the situation earlier last decade, when there were failures, it appears to have been relatively trouble-free lately – despite risks such as potentially being exposed to a single asset, or a single tenant who can default if their business doesn’t go well.

Returns have been about 8.5-10 per cent and there has been huge expansion in syndication with very few warning flags. Syndication is used widely with commercial, industrial and retail properties – the bigger end of the market – and not so much with residential properties.

But not everyone is happy. The Financial Markets Authority, Te Mana Tātai Hokohoko (FMA), has raised red flags: “Property syndicates are often advertised as providing regular income, with attractive returns quoted. However, syndicate structures can be complex, there are risks to be aware of, returns are only estimates, and you may struggle to get your money out.”

For developers, the 10 per cent deposit that buyers pay on a promised but unbuilt home is the first stage of funding, giving them their initial taste of cash, often before the diggers arrive or any concrete is poured.

It used to be that developers would then take those deposits to a bank and seek funding for, say, another 40 to 60 per cent of the project.

Now, there’s something relatively new for the residential developers. Some apartment/townhouse creators have lately had to become far more flexible in the way they get the cash to build their projects.

The developers are creating their own third-tier mini-banks via these relatively new wholesale or qualifying investor funds, offering attractive interest rates of about 10 per cent which pull in people who are often older and cash-rich.

The information memorandums for these funds are long and technical and can be challenging to read, so potential investors are advised to run them in front of lawyers or accountants before signing.

Via this method Williams Corporation, NZ’s busiest privately-owned housebuilder, established three separate funds for its money, albeit at arm’s length, to escape less accessible, more stringent traditional borrowing avenues which would have starved it of cash.

Horncastle, a Williams co-founder with Blair Chappell, said his business had three funding arms, including Williams Corporation Capital First Mortgage and the oldest and largest, Williams Corporation Capital.

All up, $148.7m has been raised from qualified or wholesale investors, with offers going out in New Zealand, Australia and Singapore. Williams Corporation’s businesses have drawn just under $135m of that to build homes in Auckland, Wellington and Christchurch.

Apartment or townhouse presales must exceed 70 per cent before building begins, says the 82-page investor information document for Williams Corporation Capital.

Investors who buy into one of the three Williams funding arms purchase redeemable preference shares, with the promise that their money can only be used for Williams’ development, land purchase and building expenses.

Horncastle and Chappell have themselves put $5.3m into the funding vehicles, and investors are told to take independent legal advice before buying the shares.

Asked why the funds were established, Horncastle says: “This was done to provide a secure, affordable pipeline of capital so we can consistently build affordable homes.” To put it another way, he didn’t want the bank manager telling him what he could and couldn’t do.

The return? An attractive 10 per cent forecast annually, with quarterly dividends. Lawyers Lane Neave have governance of those funding arms.

And how do investors get their money out? “If funds are available, we have to pay out immediately,” Horncastle says. Williams guarantees the money will be repaid in six months “but if 33 per cent of people try to withdraw their funds at the same time, we’re allowed to extend that period to 12 months to allow us to deliver our work in progress safely to our clients.”

Qualifying or wholesale investors must fulfil specific criteria, such as tipping in at least $750,000 or having net assets or turnover of $5m or more in the past two years. But Horncastle said deposits of $100,000 or lower are taken from qualifying investors who are sophisticated and qualified to buy in.

“Retail” investors – people with less ready money and/or less investing experience – are barred from Williams’ offers, says the information memorandum.

Residential developers Charlotte and Kenyon Clarke’s Du Val Group has a model with similarities to the Williams funds.

It gets money through the Du Val Mortgage Fund, also forecasting 10 per cent quarterly returns, although the FMA asked it to remove advertising likely to mislead or deceive investors.

Clarke said last year the fund had raised about $20m from wholesale or qualified investors and “we have not had a single concern”.

But the FMA said statements said the fund had claimed to have “the best of both worlds”, with both high security and high return, comparing it favourably to bank term deposits but without taking a balanced view of the risks. Du Val vowed court action but has said nothing further on that since.

Two years ago, John and Michael Chow’s Stonewood Homes launched Stonewood Capital in an event attended by Sir John Key.

John Chow said it was to provide an alternative to bank funding for developments by Stonewood Homes franchisees and licensees. The first venture was a $25m residential property vehicle. That initial target could be extended to $50m, depending on demand.

Then on Tuesday, Key, John Chow and Max Key announced the new Stonewood Key Capital, aiming to raise $100m from wholesale/qualified investors and build around 500 homes a year.

That raised eyebrows in some quarters of the finance sector, given Key’s role as chairman of New Zealand’s biggest bank.

“I’m gobsmacked the chairman of the ANZ would do this,” said one financier. But Key said he viewed residential development as a growing area, given New Zealand’s need for migrants.

Key said he had always had a passion for real estate investment and viewed it as an extremely sound asset class in a growing country like New Zealand, which has long-term migration needs.

“New Zealand, with its property-owning democracy and historically strong migration patterns makes property development a sought-after asset class,” Key said, adding that he has known the Chows for a long time and respected their business acumen, attention to detail and work ethic.

Other businesses are also busy raising wholesale funds.

Christchurch’s Wolfbrook Capital, for example, was established as a funder for developer Wolfbrook Residential, again offering wholesale investors 10 per cent but this time paid monthly instead of quarterly.

New Zealand’s largest non-bank lender – First Mortgage, Trust headed by Paul Bendall – isn’t a developer but takes depositor funds, unlike most other non-bank lenders these days.

First Mortgage Trust’s investment fund stands at $1 billion, it says, and it has provided returns to investors for the past 25 years, although those returns are far lower than the new developer mini-banks: currently 5.19 per cent to 5.58 per cent.

Princes Wharf-based Reesby & Company founder Martyn Reesby is one of New Zealand’s largest non-bank financiers. He says big Hong Kong businesses have withdrawn from the market lately, creating a lending chasm.

At the same time, major trading banks are reluctant to fund many smaller projects which potentially have high lending risk .

Big lenders out of Asia, particularly those with Chinese connections, have provided billions previously, he says. With them becoming less active, the lending scene changed.

“So there is not enough non-bank funding around and yet lots of developments on,” Reesby says.


Look before you leap – that’s the firm message to wholesale investors. Here is the agency’s advice:

Am I really sufficiently experienced?
Wholesale investors are assumed to be experienced, sophisticated investors. How do I qualify to be experienced? Does a certain amount of money really make me experienced or sophisticated? Do I feel experienced? Why does this product require me to be experienced?

Am I happy with fewer protections?
I will have fewer protections with this investment including less disclosure about risk, than I would with other investments. How do I feel about that? What is so appealing about this investment that I am prepared to volunteer to be less protected?

Do I understand the risks of this investment?
What are the risks of this investment? Where are they disclosed or explained and, if they are not – or they are difficult to find – why is that? Are they larger or more varied than with other investments? What does the provider say when I ask them?

Do I understand the basis for the advertised returns?
If specific returns are forecast or expected as part of the advertising and disclosure, what is the basis for that? And what are the risks of the return being less, or nothing?

Mez money: Expensive – and worse when you’re late repaying

Question: What is the price of a loan default when you’ve borrowed mezzanine money?

Answer: Bordering on horrific, even at last year’s lower interest rates. Would you believe 21 per cent?

Some investors in a scheme that failed said that in hindsight, they didn’t know about the true risks (even though they were in the disclosure statement).

But those who sank money into failed West Auckland retailer Nido found out the hard way about loan defaults to a mezzanine funder.

“If we’d known none of the trading banks would fund this, we never would have bought shares,” said one investor in the failed scheme to provide $62m to Vinod Kumar’s business.

The investors once owned a huge new homeware and lifestyle store, the 27,000sq m Nido off Lincoln Rd, Henderson, a shop now permanently closed after the concept failed. The property has since been sold.

Some of the investors are retired farmers who live in Taranaki and said they had no idea of the risks involved when they put in sums of up to $1m, on the promise of an 8.5 per cent annual return.

Nido was meant to be this country’s largest homeware, furniture and lifestyle business, trading from the 2.7ha building.

To fund the scheme, Kumar’s business had borrowed from Pearlfisher Capital. And when his business defaulted on loan repayments, it had to pay that punitive 21 per cent and the property was sold in a mortgagee sale.

The Nido store was built on land paid for with $30m raised by Maat Consulting through a proportional share ownership scheme and $25m of debt from Pearlfisher Capital, a non-bank lender half-owned by investment bank Jarden.

Another $7.5m came from the vendor of the property and the ultimate tenant, Nido founder Kumar.

Investors were offered shares in Central Park Property Investment, with returns forecast at 8.5 per cent.

Tony Abraham, Pearlfisher Capital founding shareholder and a director, said last year that his business was the first mortgagee funder of the land and buildings where the Nido store was constructed. Pearlfisher had loaned the money to Everest.

Mark Francis of Augusta Capital and Mark Schiele of Oyster raised concerns about the Central Park Property Investment scheme.

Francis didn’t think investors really knew what they were getting into.

“Joe Public retail investor doesn’t know the difference between a managed investment scheme and a company share offer and nor should they be expected to understand the subtle difference which according to the act, means that one offer has to be offered by a licensed manager like Augusta, and one can be offered by literally anyone with no expertise, so long as they think they are representing it fairly,” Francis said at the time.

Oyster Property Group chief executive Mark Schiele said Oyster had looked at buying the Nido land and buildings but had doubts about how successful the retailer would be, given that it was untried. The subsequent failure and receivership of the retailer and its imminent closure was unfortunate, he said.

Non-bank lender Alpha First Mortgage Investments director Scott Massey noted the Nido investors had lost around $30m. They were told only 14.1 per cent of their original capital would be returned, he noted, resulting in the substantial loss.

That showed that investors who choose to put their money directly into commercial property, whether through a syndicate or on their own, also take 100 per cent of the risk, he said. That didn’t seem right to him.

“The fact that the lender got paid before the building owners shows how in this type of situation there is more risk to investors in the property ownership rather than the mortgage lenders,” Massey said.

In commercial property ownership, he said, the real risk was generally in the last 20 to 30 per cent of the value of the property.

Mortgage businesses like Alpha only loan 50 or a maximum 60 per cent of a commercial property’s value, meaning there was far less risk for investors choosing to invest their money in lending rather than ownership, he said.

“Over the hundreds of loans Alpha First Mortgage Investments has completed, not a cent has ever been lost by investors,” said Massey.

He notes how syndicates seem safer than the wholesale funds.

“Syndicates have done a very good job of providing an avenue for people to invest in commercial property; long term the value will probably go up, but it is always dependent on the tenant being able to pay the rent. Generally, a vacant building’s value is less than when it is well-tenanted,” Massey says.

Syndicate investors did stand to gain in the capital growth on a property over the long term, which was not available through investing with a mortgage lender, but as investments in mortgages were generally short-term, when the investment was returned new investments could be made, he said.

“I’m an advocate of property syndication but where the risk is low such as with supermarket operators or fuel companies as tenants, but not when there is clearly risk of the tenant not being able to pay the rent,” Massey says.

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