Stephen Watson and Andrew Ward on project finance
As oil prices continue to spiral downwards, developers and construction companies in the GCC are being forced to come to terms with a new reality, where they don’t have access to the lavish funding that once fuelled the region’s extraordinary development.
Prior to the global financial crisis, projects in the region, and especially in cities like Dubai, found investors and financial backers relatively easily, no matter how outlandish they may have been. However, post-crisis, investors and lenders became increasingly wary of backing projects that didn’t have clear monetary value. As a result, projects became increasingly sober and tailored towards the needs of the market, while only the big developers – ones with quasi-government status – chased the big, extravagant projects.
Despite this reticence from the market, the falling price of oil has seen countries in the GCC shift their focus towards spending on vital infrastructure and economically significant construction projects. Therefore, those in the private sector looking to build and develop their own projects will need to look at viable, alternative sources of funding for their projects.
It is this scenario that brings Big Project ME to the offices of Affric Infrastructure Advisory, a boutique financial and commercial advisory firm which specialises in helping clients raise debt and equity funding for projects in the infrastructure, real estate and utilities sectors.
Comprising a team of former Ernst & Young Infrastructure Advisory and investment banking professionals, the firm offers clients what they call a “more personal, bespoke and costeffective advisory solution, while still providing the skills and experience of banking and Big Four advisory professionals”.
Stephen Watson, managing director of Affric, is something of an infrastructure specialist, with more than 18 years of experience advising government and private sector developers within the three sectors. Having set up shop just 18 months ago in Dubai’s JLT district, he’s now turning his sights to the UAE’s construction market, as he sees a major opportunity for firms like his to open up new avenues for clients.
“The market is changing significantly; however, good projects remain fundable,” says Watson. “However, with the fall in oil prices restricting liquidity in the senior debt market, access to capital is getting harder. Developers are finding funding more and more difficult to source from the banking community and are looking for alternative ways to fund projects.”
So what is a good project? Andrew Ward, a director at Affric, explains: “A good project is economically viable, has the right capital structure and provides appropriate security to funders – if these foundations are in place, then there are always ways to finance a project.”
He continues: “2016 is undoubtedly going to be a very challenging year from a funding perspective. Senior funders are retrenching and only extending facilities to a very select customer base, if you don’t have a strong relationship with them, or if you don’t have existing yielding assets that you’re willing to provide as security, then you’re going to find it very difficult to source funding from the senior debt market. As a result, the up-front structuring of a project is even more important for our clients.”
But even for well-structured projects, funding will come at a price. “Everyone has to get more realistic about where the market is going,” Ward says. “Government-backed infrastructure projects will still attract multiple funders and competition to provide funding to these projects will be fierce. But for everybody else funding, whether it’s debt or equity, is going to cost more. That’s the reality of it.”
Ward continues: “As a developer, you have a straight choice:
“Option 1 – You can sit looking at your patch of land and wait for the prices to go up, or wait for liquidity to come back into the market.
“Option 2 – You can accept where the funding market is and take the higher cost of funding.
“Option 2 may not be palatable to some, but it provides the huge advantage of giving the green light on the project and making it real. Then you can start construction, start the sales process and start generating profits. Meanwhile, those taking Option 1 are still looking at their patch of desert.”
This choice becomes increasingly stark for developers looking at the residential real estate market, says Stephen Watson. “Going into 2016, the view from the banks and funders is that residential real estate will remain highly challenging to finance as there is perceived to be an oversupply in the market. Private equity and real estate funds remain active in this market – but these funds are expensive.”
“Developers really need to ensure their financial feasibility studies are robust and can absorb the higher cost of finance, and this is where we can help. But given the prevailing economic conditions, that choice is something developers and investors in the region will have to think long and hard about. While the funding is available in the market, it is going to be expensive. Ultimately, a developer will simply have to decide whether or not they want their project to succeed.
“However, I think that those capital projects that hit a gap in the market, where there’s a strong demand for their services, those will always be fundable. These projects need to have good counterparties, so that means either a strong developer, a strong construction company or a government or quasi-government agency sitting behind.”
Developing funding structures in this market is a complex process. This is perhaps best illustrated by the structure Affric put together for the relocation and expansion of a primary school in Jebel Ali, which took nearly six months to develop.
“That was a complex process,” says Watson. “JAPS is a not for-profit entity and therefore did not have the ability to raise finance. Combining this to the requirement of Institution Funding via Emirates REIT was a complex process which led to a lot of late nights and difficult discussions.”
Andrew Ward says, “That was a complex deal. But not all projects are like this and most of the key issues can be addressed during the initial feasibility assessment.” Ward adds that the firm also conducts initial feasibility assessments for developers who come to them with ideas for projects and want to know if they are financially viable. “We can do all the work necessary to say, ‘Right, that initial feasibility assessment – before you do anything, does that make sense?’”
“This is a key document for any project. It doesn’t have to be hundreds of pages, but it does have to be robust,” Ward continues. “We have worked with lots of developers at this initial stage, supporting them to present a project structure that is financially viable. We help them shape their strategy, build their financial models and present a project that ultimately makes financial sense.”
“That initial work for developers, to ask them, ‘Does this make sense? Can we go have a sensible conversation with banks?’ The feedback we’ve had on that has been really good.
“I think this is our real area of distinction in the market. I hate to use the word disruptive, because it just sounds like a cliché, but I do think that we have been disruptive to the market, to an extent. We are aiming to bring a different quality of work and a different quality of assessment, and this reflects the feedback we’ve been getting from developers and from funders,” he adds proudly.
“The feedback we have had from the market is that our name stands out, and when people see the Affric logo, they know it is a serious proposal that is worth spending time and effort on. “But that doesn’t always mean our advice is accepted. I have never understood why developers have always relied significantly on pre-sales to fund their developments and not had sufficient funding in place for the full development.
“Why would you put one dollar into the ground unless you knew that you could build all the way to the end? At the very least, if you can build to the end, then you can manage the development and sales process in parallel and manage the funding of the development, then say, ‘Here’s the finished product. We can do something with that,’” Ward explains, gesturing out the window to a half-completed tower.
Despite the pitfalls, this approach continues to be prevalent in the Middle East, evidenced by the number of buildings that stay half complete for years, many of them likely to never progress from there. “Pre-sales continue to be seen as a route for project funding, and in the current market, this remains a high-risk strategy,” explains Watson.
As many know, Dubai’s development has been based on a pre-sales strategy. Back when the economy was high and when investor capital was flowing into Dubai from all corners of the globe, banks lent heavily into those types of projects. Apartments, villas, entire residential communities, were all being sold off plan. What this meant, Watson explains, is that builders didn’t have all the capital to build out their projects, because everything was coming from pre-sales. However, this worked, as investors were hungry to invest into the Dubai success story.
“Obviously, after what happened in 2008/2009, banks were a lot more wary of projects seeking to finance based on a pre-sales strategy,” says Watson. “This is a reasonable argument. Effectively, by relying on presale, developers are transferring a large proportion of sales risk to the funders and, given the perceived oversupply in the market, funders are a lot more wary of exposing themselves for fixed returns, particularly when banks have less liquidity.”
Andrew Ward chimes in: “If you’re starting a project now, I think the key is to make sure that you have financing to complete the whole project, without relying on pre-sales, particularly in the residential sector. If pre-sales can be generated, this is great, but you can’t build a business case on them. Having that as your key source of funding makes a project very difficult.”
In order to take advantage of this rapidly evolving marketplace, Affric’s leader says that he’s keen to use the strong relationships he and his team have built up in the regional construction industry to allow his young company to flourish.
“Predominantly,” says Watson, “the opportunities for Affric are focused mainly on existing relationships. It’s based on the relationships we have within the market, with developers, the larger construction companies, as well as the technical advisory and project management firms here in the UAE.”
Affric tends to deal with two types of clients, Watson adds – Western-based multinationals with operations in the GCC, and local, home-grown organisations.
“We’re looking to do work with these organisations, if we’re not already working with them. And we’re speaking to them about different funding options for different types of projects. One of the areas we will be focusing upon is working with our construction clients, so that they’ll be able to take not only construction solutions but also financing solutions to their developer client base.”
The funding market is set to change in the UAE and the wider GCC in the coming years, and both international companies and home-grown firms will need to put more thought into how to fund capital projects and not just rely on their tried and trusted partners in the banks.
With traditional funding sources proving difficult to tap into, both Watson and Ward say there will have to be a period of education in the local market as it comes to terms with the fact that structuring of projects is key to access funding, and that this is where Affric can assist its clients.
“As a result of market and economic conditions, we’re starting to have discussions with both types of clients. They’re starting to see the need for different types of funding structures,” Watson points out. “But it keeps coming back to the point that good projects remain fundable. We keep reiterating that [to our clients].”
Affric also offers a plethora of other services to its construction clients, but one particular service bound to attract the attention of construction firms and developers is their offering of Tender Support. Often a source of considerable angst to contractors, having balanced tender documentation and tender packages is something that both Watson and Ward are keen advocates of. Together they have worked on both sides of the table over the years, and the duo are adamant that having the right kind of tenders issued into the market will solve a number of problems projects encounter during the development and construction phases.
“The development of the tender documentation is so important to the success of the project,” says Ward. “Particularly where the tender requires the construction company to source finance for the project. The tender document itself must be coherent, setting out exactly what is required, by who, and by when.”
“If a project is being funded by a developer’s own equity, then it is possible to retain a large element of flexibility, but as soon as third-party external funding is involved, that flexibility has diminished significantly or even gone. Funders want to know exactly what is being built, how much it will cost, and how and when they will get repaid.”
Watson continues: “In addition to being clear and concise, a good tender is a balanced tender, one that understands the capabilities and limitations of the private sector. The reality is that contractors can’t take every single project risk, nor should they be required to. However, the desire to push everything down to the contractor level means the contractor is just storing issues up for down the line when the project starts to be delayed or the funding runs out.”
The discussion in relation to contractor risk quickly leads to PPP, and its ability to solve the funding of infrastructure in the region. Both Watson and Ward have significant experience in the PPP market, having advised both public and private sector clients in the GCC, the UK and Australia.
“There are a number of factors that are required to unlock the PPP market here in the GCC,” says Watson. “There are macro issues such as PPP laws, a centralised PPP unit, a developed funding market, as well as micro issues such as robust feasibility assessment, high quality procurement documentation, appropriate allocation of risk, cross-departmental working, the provision of appropriate government guarantees – the list goes on.”
“But the impact of oil price and its impact on sovereign reserves mean governments around the region will increasingly look to PPP as a way of funding capital projects in the region. The UAE and the wider GCC, however, has a good track record here, as the basic principles involved in many PPP structures have been used successfully in the region for a number of years through the various IPP and IWP projects.”
Discussing the new PPP law, Ward is more sanguine: “The introduction of the new PPP law in Dubai is a welcome development, but in itself will not have an immediate impact. However, its introduction does provide a useful background for investors. For international investors in particular, the use of the new law provides a defined structure for how these projects will operate and how investors can be protected – this is fundamental when seeking foreign investment into projects.”
So what’s the outlook for 2016 from Affric’s perspective? “It’s been a great year for Affric. Closing the Jebel Ali School deal and winning the ME Consultant Team of the Year Award at Big Project ME’s sister magazine’s awards night were great achievements for our team,” says Watson.
“2016 is going to throw up some real challenges in funding capital projects, but with the right structure, these good projects in the UAE remain fundable.”