Although Build to Rent in the UK is a relatively new sector, it has rapidly gained dominance. Many developers and investors are eager to benefit from the security that investment in Build to Rent offers.
Each developer and investor operate differently and set varying financial goals. To achieve a mutually beneficial investment, funding plans for the development must suit the developer and the investor’s financial goals.
An understanding of the deal structure for a BTR project will determine the extent to which the project is beneficial for each party’s interests.
Below, this article will explore the following basics: What is a deal structure? And the most common types of UK Build to Rent deal structures.
What is a Deal Structure?
In investment activities, a deal structure refers to the terms i.e. the rights and responsibilities the investor and developer agree to undertake. A deal structure can be found in virtually any transaction where assets and interests of parties are concerned.
Deal structures come in various forms. They set out how investors and developers (keen on benefitting from the reliable rental returns of BTR), fund a project. Furthermore, shared responsibilities and distribution of returns is outlined.
The most common deal structures for a BTR are:
- Forward Fund
- Co-invest
- Raise Capital Through Debt
- Joint Venture
We will outline these structures below.
Forward Fund
Forward funding is a deal structure with all the costs of constructing provided by the investors. Agreements are designed so that upon completion, investors assume control over the development. In this structure, developers are more like contractors. Paid beforehand for all the costs needed to execute the development.
The main benefit of a forward fund deal is that it ensures a greater return on investment for the investor. Conclusively more than they would achieve if they had purchased an already completed development. This deal structure provides cash flow benefits for the developer. Funds are received upfront, as opposed to after the development is completed.
There are certain disadvantages of this deal structure. Above all, there is a higher risk involved with constructing a development rather than purchasing a completed one. Unforeseeable constraints can frustrate the process of development permanently, or lead to an increase in costs of construction.
An example of a forward fund deal structure is illustrated by Grainger, one of the UK’s largest professional landlords. Grainger recently entered an agreement to forward fund and acquire a BTR development in Cardiff for £57 million.
Co-Investment
A co-investment is an arrangement whereby a minority investment in a project is made by investors with the main company. Co-investment can be viewed as a form of equity financing. Consisting of investors whose ownership stake in the business is limited to the percentage of their investment.
This deal structure allows BTR developers to offer developments in equitable portions to investors seeking to benefit from its RRI, equal to percentage invested.
Co-investment allows investors to benefit from potentially high returns, while BTR companies are provided with capital to carry on business. There is also shared risk amongst both parties i.e. both parties bear any profit or loss on the development together. This form of deal structure suits the long-term structure of Build to Rent.
A shortcoming of this structure is the time taken gathering enough investors to join the investment. Additionally, it involves high risk as both parties earn returns only once the business makes a profit.
An example of a Build to Rent company that offers a co-investment option is Henley Build to Rent.
Raise Capital Through Debt
This deal structure is also a form of debt financing. Which, is when a company raises capital (operating capital or capital expenditure) needed for business. It does so by selling debt instruments (borrowing) like debentures, bonds, loans, etc. to investors. By raising capital through debt, investors are now known as creditors of the BTR company. The creditors are to be repaid with an agreed interest on the principal debt borrowed.
The pros of raising capital through debt are that the company retains complete control and ownership over the development. Profit-sharing is solely within their powers too. When compared with co-investment, the interest rate on the loans is relatively lower than equitable investments.
The cons of this deal structure include the high risk of defaulting on debts. This puts the investor at major risk of losing its assets. This is because there is no shared risk between the creditors and the company.
Joint Venture
Joint Ventures involve an arrangement between two or more business entities agreeing to share the following: Expenses, ownership, control, & ROI on a project they want to jointly accomplish. The project is the venture the parties to the arrangement jointly seek to achieve. This venture itself is an entity separate from the other business interests of the parties.
A JV deal provides companies with the ability to leverage resources they have individually, for the benefit of the venture. By leveraging on their resources, parties to the venture lower their cost of production. Also, the venture is likely to thrive as all parties bring their expertise and the risks are also borne jointly.
However, flexibility can be restricted and decision-making slow due to the need to consult with all concerned parties. Furthermore, with companies working together, there can be an imbalance of effort, contribution and investment. All of which can stunt the growth of the development.
Conclusion
Even with these common deal structures outlined, one should remember there is no magic formula for any one deal structure. It is dependent on each of the parties involved to evaluate the merit of each structure and move forward accordingly.
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