Home-made Solutions
The experts talk about the changes in project finance and how developers are looking at alternative sources of finance to help bring back the boom times
Ever since the Middle East discovered its oil reserves, development through construction has been one of the founding principles that the region has built upon. Nowhere else has this been truer than Dubai.
A sleepy trading town a mere 40 years ago, the city has exploded into a bustling metropolis that can measure up to the finest in the world. It’s no exaggeration then to say that Dubai serves as the benchmark for a region that is striving to make its own mark on the global map.
Being a construction pioneer, Dubai has helped the GCC adapt and change the way it approaches the building industry in many ways. However, following the downturn in 2009, the UAE emirate could have the most important lesson of all to teach the region.
As the money flow slowed down during the dark days of the crisis, construction in Dubai ground to a virtual standstill. Not only was there no money available to start new projects, but existing projects were forced to stop midway through their construction cycle.
As the real estate market worsened, developers had to become increasingly clever about how they obtained funding for their construction projects. Banks have become increasingly wary about lending money to projects that do not have clear feasibility studies, while developers themselves have had to start looking at alternative sources of funding, such as Islamic finance and local banks for the money they need.
Debbie Barbour, a partner in the Abu Dhabi office of DLA Piper, is a highly experienced project financing lawyer who has worked extensively in the region. She believes that banks have begun focusing on premium projects that are being developed by participants with a solid track record, making things more difficult for smaller developers who may not have the same extensive history.
Debbie Barbour of DLA Piper.
“When I moved to Abu Dhabi in 2008, there was a lot of talk about project finance in the region and a lot of deals were about to take off, but obviously with the crisis hitting the UAE in 2008 and 2009, those deals got put on hold,” she says.
“However, we’re starting to see those projects coming back now.”
What has changed however is that developers are now looking more towards local banks for funding, mainly because of the turmoil European banks are facing thanks to the Eurozone debt crisis.
“We’ve seen that some of the European banks are struggling with their own issues. While some of the larger European banks that we traditionally deal with for project financing are interested in projects in this region, we’re seeing more and more local banks expressing an interest in project financing. [They’re] stepping up to the plate and providing that finance.
“Obviously, they’re quite limited in what they can offer, so perhaps they can’t lend the large amounts that were on offer pre-2008, but we’re certainly seeing smaller deals being financed,” she explains.
However, Nicholas Maclean, managing director of CBRE Middle East, points out that because banks were still proportionately more exposed to real estate lending, developers still have a difficult time in obtaining financing for projects.
“The route to financing from banks is not nearly as strong as it once was, because banks are proportionately still highly exposed to real estate lending. As a proportion of their overall lending, real estate is much higher now, that comes about not because banks have increased their lending, but because the relative value of property to what it was three or four years ago,” Maclean says.
Furthermore, one of the biggest problems developers, especially those operating in Dubai, face is that a large percentage of their funding for projects used to come from off-plan sales. Unfortunately, as Maclean explains, one of the effects of the down turn has been a significant drop off in terms of the trust investors have in off-plan sales.
Nicholas Maclean
“The trust in off-plan sales has not fully recovered and therefore, the amount of funding you can attract for new schemes is variable, it’s definitely significantly less than what it was three or four years ago.
“So what we really need to see are alternative sources of funding and to get the banks to come back into the marketplace,” Maclean asserts.
One such method of funding is to involve corporate investors in financing, he says. With state-backed investors having a vast amount of capital behind them, Maclean suggests tapping into those funds to help rejuvenate the market and boost confidence.
“Some of the state-backed investors should be encouraged to provide funds going forward. They haven’t previously been active in this marketplace, but I think they need to be encouraged, particularly if the banks aren’t as active as they were historically and we don’t have off-plan sales,” he adds.
While this is one alternative, Paul McViety, legal director and an Islamic Finance expert at DLA Piper, says that there has been a surge interest in developers looking at Islamic finance as a viable alternative to conventional sources of income.
“There are three key driving factors; first and foremost, it’s an additional source of liquidity. With the continuing crisis in the eurozone, you have few European banks looking at the regional project finance market, (as Debbie mentions). The result is that there has been a switch in focus towards looking for as diverse a pool of funding as possible,” he says.
“The second reason is that there are a lot of corporate firms in the region, particularly in Saudi, who operate on a wholly Sharia basis, or have a preference towards obtaining Islamic finance over corporate funding.
“The third reason is that when you consider jurisdictions such as Saudi Arabia, historically, there has been conventional financing that has taken place, but the large part of that has been done on the basis of the SAMA Committee’s understanding of conventional financing techniques, and their willingness towards interest,” McViety continues to explain.
Paul Mcviety
“Whereas, for Islamic finance, the Islamic committees uses a very different basis in terms of it being asset based. The returns [on investment] are generated through rental profits [for example]. What you find is that there is a perception, certainly in the Saudi market, that were a financing structure to be adjudicated upon before the local courts, Islamic financing would be on a far better footing than conventional finance,” he adds.
One good thing that has come out of the collective tightening of belts from banks and financiers is that developers have been forced to become a lot clearer in the way they operate.
As Maclean puts it, if developers cannot provide investors with the right structures, such as guarantees of Escrow, guarantees of the recovery of funds, etc, then it will prove very difficult for them to obtain funding.
“The benefit Dubai has had after going through the difficulties is that developers have got to be more organised than they were earlier. The trust has not fully recovered, and therefore the amount of funding for new schemes is significantly less than four or five years ago,” he says.
McViety adds that from a legal perspective, there has been a stronger emphasis on having legal documentation which will pay off in the long term.
“The market has undoubtedly seen an increase in the quality and standard of legal documentation over the last 10 or 15 years. In many ways, the project financing documentation that is put together, if you look at common term arrangements, inter term arrangements, etc, they do follow a very international approach [now].”
He adds that the region is starting to realise the benefits that come with having clear legal guidelines when it comes to project financing, citing Saudi Arabia’s long-awaited mortgage law – along with four other new laws – as a positive step that will help clear up a number of issues that financiers have faced over the years.
“There is a hope that once the mortgage law is passed, and it hasn’t been passed yet, it will rectify or solve a lot of issues that financiers have grappled with over a number of years and clear up some legal ambiguities,” he explains.
Clearly then, the lessons have been learnt across the GCC and as the market continues along its path of recovery, it is clear that investors will be able to have a clearer idea of where they stand, both from a legal and financial view point.
