The cost of recession

As one of the most pertinent topics in the construction industry today, the issue of project finance is one that continues to spark debate among the region’s key professionals. Across the board, they agree that access to finance is getting easier, but diverge on the subject of how to move forward. At the centre of the controversy, is the argument over whether banks should be doing more.

It all started for the sector’s financial departments with a sudden shift in bankers’ attitudes. Almost overnight, there was a switch from a strong confidence across financial institutions and an easy period of asset-based lending, to a strict clamp-down on borrowers and a sudden realisation that the market was plummeting.

“When cashflow was positive, predictable and consistent, and the market was excited about the sector, the banks were falling over themselves to fund construction projects, and there was no shortage of project finance available either in local markets, or for expansion,” says Arabtec CFO Ziad Makhzoumi. However, in the wake of the crisis, he explains, companies that were undercapitalised and left with outstanding receivables were hit hard by restrictions on bank loans, as it meant they didn’t have the necessary funding to expand into new markets.

Unfortunately, the main problem with the lack of available funding today remains much the same. According to experts, limited financial support both for developers and contractors is what’s keeping the market in a period of stagnation.

“The truth is that the economy is starting to improve, but unfortunately, because of the real estate overhang, the growth is being eclipsed,” says Jones Lang LaSalle’s director of capital markets for the MENA region, Gaurav Shivpuri. “In the real estate sector, better access to finance would allow firms to finish projects and hand them over to end-users. It would allow developers to pay contractors and ensure money is supplied back into the economy. The money needs to move around to ensure the economy continues to remain vibrant.”

For many companies, one of the big questions at the moment is why, if the economy is improving, are banks are still veering away from lending.

“The encouraging news is that we are slowly seeing financial institutions extend new loans to developments that deliver a convincing and clearly communicated value proposition,” explains BCG Middle East partner and managing director Sven-Olaf Vathje. “But financial institutions are still cautious and expect proven business cases and risk sharing models before they consider financing. The days of ‘easy money’ and balance-sheet lending are over.”

Shivpuri agrees. “The market is particularly tight for lending to speculative projects,” he says, “so projects that have limited or no commitment of sale during construction, or lease following completion.”

Under such circumstances, industry professionals have come up with a range of possible solutions for overcoming the problems. The first, perhaps most obvious, is to look beyond real estate developments, towards a more stable sector such as infrastructure. Shivpuri explains. “Assets in non-core sectors such as healthcare and education have more appetite as the supply in these sectors is not significantly higher than demand. Moreover, most of the development in these sectors is customised for an end-user or operator. Moreover, the covenant of the operator or lessee allows for the mitigation of the risk in loan payback.”

Vathje agrees. He argues that when evaluating business plans, financial institutions look for predictable and stable revenue streams, which characterise infrastructure projects, contrary to office and residential projects which are in oversupply, and thus facing difficulties.