The crisis of capital
One of the biggest challenges for property developers in Vietnam today is obtaining finance. Illiquid credit conditions have led to a crisis for many developers who need to secure capital in order to get their developments off the ground. In a sector that is highly leveraged, many developers are stalling their developments in search of capital whilst some are under threat of losing investment licenses. The government’s recent measures to combat inflation have put a further squeeze on credit to the property sector. It requires local lenders to reduce their lending to “non production” sectors to 22 per cent of total loan structure by June 30th and to 16 per cent by December 31st 2011. Currently, bank loans to the property sector account for approximately 20 per cent of total loans, and following this new directive, this will decrease. With further monetary tightening being carried out by the government, current interest rates approaching 30 per cent and banks unwilling or unable to lend, property owners and developers are having to be innovative to source finance from means other than bank loans.
Self financing from pre sales or phasing
In terms of project specific financing, there are a number of different options available for developers. The most obvious way of financing is to partly self fund a project through pre sales or through the carefully phasing of the development. Following government legislation, pre sales off plan are not allowed. Pre-sales can only occur once a number of conditions are met, notably the foundations of a development are complete. Financing through capital contribution contracts and Business Cooperation Contracts can begin before the foundations are complete, although this has been restricted by Decree 71 to 20 per cent of the total units of a project. A successful pre-sales campaign can help finance an important part of the development. Selling and self financing through phasing is obviously limited to suitable projects, for example a mixed villa and condominium development, where the sales of villas as they are being completed could fund the construction of the apartment building. This can reduce the financial burden on the developer significantly as sales from one phase will finance the next. Other similar options are available increasingly being used by savvy developers. For example, participation lending, where the lender gives advantageous rate of interest for a share in the profits is a possible way of enticing lenders and reducing the financial burden.
Joint ventures, the coming together of finance and expertise, or simply land and finance have been a long standing method of financing a project. We note there are many Vietnamese project owners who see this as a preferable solution, especially the possibility of joining with a foreign developer who brings money and expertise.
Realistically, any foreign party would carefully assess any prospective project, and would require a number of criteria to be fulfilled; a feasible project offering good returns, the land fully compensated and cleared to mitigate risk, and realistic pricing. It should be noted that foreign capital has many options inside and outside of Vietnam so the importance of setting the deal correctly in a professional and transparent way will improve the chances of a domestic developer in attracting a foreign partner.
On the corporate level, developers can raise finance through debt or equity finance. Although corporate bonds have been a solution, the credit rating of many Vietnamese companies and high interest rates make bond issuance a less attractive solution. Following the success of Vincom’s convertible bond issuance in 2009, large reputable property companies are seeing the international bond markets as an attractive forum for satisfying capital demand. This so called quasi equity, where the owner has the opportunity to convert into stock at a predetermined level has proved successful, but again this will only be possible for the largest and most reputable of companies.
Raising capital through an initial public offering (IPO) has also been an important source of finances although the current state of the stock markets has recently dampened interest.
Towards a more efficient market?
Property markets, which are neither fluid nor continuous, are less efficient than stock and bond markets due to the different participant’s varying amounts and quality of information. With a crisis of finance in today’s market, the projects that secure the capital will either be those who are cash rich or those who have the best products and best utilize the capital markets in order to fund their schemes. With the frantic development by non specialised developers that has led to short term oversupply in certain sectors, investors will analyse the market, with the best developments finding it easier to attract finance.
If the development is deemed more risky, then this needs to be priced appropriately therefore giving the investor more reward for the risk. This could lead to a more efficient allocation of resources in the market as the capital will find its way to the projects offering the best risk - reward tradeoff.
We are likely to continue to see a large number of developments delay their projects due to the lack of finance throughout 2011. We will also quite possibly see more failures and projects shelved due to lack of finance. In turn this will provide new investment opportunities for savvy buyers who may be able to pick up projects at good prices from distressed sellers. The tough times for developers are likely to continue as long as Vietnam is struggling with high inflation and the government continues to restrict credit growth. The capital requirements will be different for every company and for every project. It is therefore important that each developer receives the best advice in order to ensure the financial success of their project or projects.
The future - Real Estate Investment Trusts (REITs)?
The illiquidity and lot size of property has been a consistent problem in raising capital in the sector. There is a lot of idle money in Vietnam, privately held or otherwise that could find its way into property. A solution seen throughout the western world and increasingly in Eastern Asia is the liquid, tax transparent securitized form of property, the Real Estate Investment Trusts (REITs). Although there have been calls for this type of structure in Vietnam, notably from the Housing Development Strategy until 2020, the legal framework and the domestic stock market is not finished yet.