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Tue 13 Jan 2009 04:00 AM

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Finance — my way

Dr. Sulaiman Al Fahim, chief executive of Hydra Properties, reveals how to raise money in a downturn.

Dr. Sulaiman Al Fahim, chief executive of Hydra Properties, reveals how to raise money in a downturn.

"Ah yes, but you were born rich. Or if you were not, well, somebody just gave you all that money. You were lucky. You woke up one day and found a pile of cash."

These are just some of the many theories I still hear today from people trying to figure out how it is that a man like me, 31 years old, can put together a billion-dollar deal to launch a new project.

I am a fan of raising equity finance. I find it is the best way because you are diversifying your risk.

It is generally assumed that those of us in the property game have some secret code, or some secret access to money. It is our own little secret that people like you will never find out, and never be allowed to find out.

I wish that was true! It would certainly make my life a lot easier, and believe me, I would be the world's biggest property developer by now. The biggest Arab company in property by market value wouldn't be Emaar, it would be Al Fahim.

But life isn't like that. When it comes to financing a project, you - even though you probably don't realise it - have the same access to money that I do. There are in fact only a limited number of options. It is a case of knowing what they are, which are best for your project, and then using your knowledge and skills to make them happen.

Unless you were born with a billion dollars set aside for you, then there are really just five main options to finance a development.

Funding options

The first is the most obvious and oldest type - you go to the bank and get a loan. Some of you have done it for a car, or to pay your rent. Maybe even to take a nice holiday, or get married. Well, you can do the same for a US$200million project.

The second option, which is becoming the latest trend in the market, is equity finance, whereby you raise funds from retailers and institutions, and give them a share in the project in return.

A third option is raising funds through a sukuk or bond sale (usually for projects of US$500million or more).

Fourth is pre-sale. You can sell most of your project to buyers before one brick has been laid, using that money to actually build the project. Fifth is the yielding business whereby you can rent out part of your building for one year in advance.

This will give you good mezzanine finance to start the project and then the banks can finance you later.

Finally, there is what I call the exit strategy - but some people are now using it at the beginning, and that is an initial public offering (IPO).

So where do you go from here and why? It really depends on the type of project and your own situation. And how much risk you want to take.

I will come to some specific Hydra examples later, but first let's look at these in some more detail, beginning with equity finance. Exactly what is it?

Well, there are a lot of smaller companies that actually use equity finance (not necessarily in the property business) and they don't even realise they are doing so. I mentioned earlier that it is the latest trend, but that is just in the Middle East.In the UK, nearly two thirds of all new businesses are launched with either personal capital or it has come from friends who take a stake in the business in return for equity.

It is popular because in theory it never has to be repaid and there is no interest to pay back on the money.

Those who give you the cash are obviously raising their own money because there is no guarantee of the investor getting their money back. If everything fell apart and was a disaster, then those who put up the equity finance are usually at the back of the queue when it comes to repayment.

For pre-sale to succeed, the most important thing you need to develop is a brand.

Equity finance

So why do they bother? Because it can be very lucrative. The return from an equity investment comes either by a sale of the shares once the company has grown or through dividends.

But for the most part, people will give you the cash so they can take a share of the business in return. Formal equity finance is available through a number of different sources, and on property developments usually comes from institutions and retailers.

What they all want to see is a business that grows. A development that works. If you cannot show growth rates of 20% for a business, or similar returns on a property development, there are not likely to be many takers in any equity finance deal you put together.

Right now, equity finance seems to be the way forward for all kinds of projects. I am sure you have heard of the 'Green City' being built just outside Abu Dhabi. Abu Dhabi Future Energy (MASDAR) said it would cost US$22billion to build the "no carbon" green city on the edge of Abu Dhabi.

It will be home to 50,000 people and 1,500 businesses, according to CEO Sultan Al-Jaber - no cars will be allowed.

A fantastic idea and a fantastic project - but it requires a fantastic amount of cash. Where is it coming from? Abu Dhabi is putting around US$4 billion into the project and will borrow the rest. According to Al Jaber, such type of financing has never been applied to a project on the scale of an entire city.

Personally, I am a huge fan of raising equity finance. I find it is the best way because you are diversifying your risk. What you are doing is putting together equity funds - you structure a product so you are selling units as shares. For example, I can put seed capital of US$10million into a project and go to end users to raise US$40million.

I show them how they can make money from the success of the project. The good thing is you are not paying interest and it generally a four-eight year deal.

Fund managers get to make their 0.5% placement fee on money brought in from institutional investors, and you are giving them shares in the project. This is one of those deals in which "everyone is happy" if it works.

Equity finance is not your only option. I talked a bit about pre-sale finance. If you can do this, if you can pull it off - which I have a few times - I guarantee you will have a huge grin on your face.The theory and practice is actually very simple. I want to build a US$100million residential development. I sell all the units long before I have started building it. My investors begin with a 10% downpayment - if I do my sums correct, that gives me US$10 million.

I give that to the contractor, who begins his work. After he finishes the first phase, my investors owe me another 10% - another US$10million - which I happen to owe the contractor again, and effectively pass this money straight onto him.

Supply and demand

In some ways, with this your return on equity is infinite because you don't even pay for the land! I call it IRR - infinite rate of return. This is the dream scenario, but it will not last forever because you will not always have a market which huge demand and short supply.

These kind of markets are very hard to find.

The liability is with the customer in this scenario. But as a developer, you have to be very careful and only use that money for that project.

I am aware of some developers who have used the money to invest in second and third projects. That can bring you trouble. A friend of mine owns ten towers but for three of them he doesn't have the money to actually build them because he used it on other projects.

This is rather like taking out a new credit card to pay for the one you have already used up but cannot afford the repayments on.

It seems like a good idea, and is very easy to do. But ultimately, you will hit a brick wall. Or in this case, no wall - you can't afford the bricks anymore.

For pre-sale to succeed, the most important thing you need is a brand. And people have to trust in you. You need to be trusted. Simple as that. If you are not, you won't get a single pre-sale.

I will come on to the importance of branding in a lot more detail later, suffice to say that it is something that I think we at Hydra have done exceptionally well on.  I have a folder in my with 1800 applications and cheques - people asking to invest in the next Hydra project.

It doesn't exist yet but they want to be first when it does -- they trust the brand. They want to be part of it. This is the ultimate pre-sale. And the ultimate IRR.

Islamic financing

Another finance option that grew in popularity over the last few years is going for an IPO before you start the development. Some developers I know of started with that because they thought there was good cash in the market.

Personally though I am not a huge fan of this - I prefer to buy the land myself, do the design myself then value it and go to an IPO route. Because that way I have assets, I have something tangible to show.

The final (in my experience) finance option is that of a sukuk, something we are seeing more of these days, though generally for projects worth more than US$500million. Back in 2002, the total value of sukuk issues was around US$1billion.By August 2006, the total value of issues in the twelve months before was a staggering US$12billion.

So what exactly is it? Let's get technical for a moment - the best definition I have found reads like this: "Although the Sukuk is sometimes referred to as the Islamic bond it is better described as an asset based investment as the investor owns an undivided interest in an underlying tangible asset which is proportionate to his investment.

"The Sukuk certificate evidences this ownership interest. Monies raised by the issue of the sukuk note are used to invest in an underlying asset, a trust is declared over that asset and thereby the certificate holder will own a beneficial interest in that asset in proportion to its investment and is therefore entitled to all the benefits that entails including a proportion of the return generated by that asset."

Evolving demands

Don't worry, I said only for a moment. What this means in straight English is that I can issue an Islamic bond to you for my project, you come up with the money and effectively own part of it held in trust. You get a share of the profits some years later when I give  you the cash back.

There are many self-explanatory examples of this, such as Liquidity Management Centre, Emirates Islamic Bank and Alpen Capital (ME) Ltd recently announced the closure of a US$130million sukuk issue arranged for Berber Cement Company.

The US$130million sukuk proceeds, along with a US$70million equity contribution by Berber Cement Company's shareholders, will be used in the development and construction of the US$200 million Berber cement project over the next 18 months.

The sukuk will be for seven years with an average life of 4.75 years and paying semi-annual fixed returns.

The above is a typical modern day sukuk deal - average life of 4-5 years. These are attractive investment products especially for affluent Muslim investors looking for investment options that comply with Shariah law.

Sukuk structures are being used for a variety of purposes and have evolved rapidly in response to the demands of issuers and investors.

Sukuk issues have ranged from the simple sale and leaseback (Ijara) structures, such as the US$1billion Dubai Department of Civil Aviation sukuk issued in November 2004, to the US$2.53billion trust finance Sukuk structure issued by Aldar Properties in March 2007.

Infrastructure projects

The Central Bank of Bahrain, on behalf of the Government of Bahrain, regularly issues Sukuk-Al-Ijara and Sukuk Al-Salam to finance various infrastructure projects in Bahrain.

Malaysia's Global Sukuk, launched in June 2002, was similarly backed by an Ijara lease on a single piece of government property. The money raised by the Government of Qatar through the $700 million Qatar Global Sukuk is being used partly to finance the construction of the Hamad Medical City.

Back in 2006, Dubai property developer Nakheel Group sold the world's largest Islamic bond after increasing its size by more than 40 per cent to US$3.52billion to meet demand.

Nakheel will use cash from its Sukuk to fund projects in Dubai, which is leading a surge in Gulf Arab investment in real-estate developments. The Sukuk has been listed on the Dubai International Financial Exchange. Adapted from the book "Brand Builder".

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