Real estate financing pills (1): forward purchase vs. forward funding

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In this article we explain two terms that are becoming increasingly common in the structuring and financing of real estate projects: forward purchase and forward funding.

  • “Forward purchase” is a contract for the purchase of a future building, by virtue of which the developer-seller undertakes to promote the construction and marketing of a real estate project within a certain period of time, and the investor-buyer undertakes to pay a price for this real estate project that has already been marketed, and which guarantees him a certain profitability. The consummation of the purchase is subject to a deadline and to the fulfilment of the stipulations of completion of the project and marketing.

It is clear, therefore, that this formula has advantages for the investor-buyer, as he does not have to cover the construction/insolvency risk of the developer, less knowledge of the project development is required and the purchase agreement is much simpler, while on the other hand, the participation rights in the construction/rental phase will be less extensive and the purchase price will probably be higher. Sometimes a down payment of 5% is also agreed at the signing of the contract.

  • Forward funding, on the other hand, is a contract for the purchase of a future building or the purchase of a future thing, whereby the developer-seller undertakes to promote the construction and marketing of a real estate project within a certain period of time, with financing to be provided by the investor-buyer.

In a forward funding transaction, the parties enter into a purchase and sale agreement with development obligations of the seller at an early stage, often before development work has started and sometimes even before the project has been secured. However, the purchase price, in contrast to the forward purchase, will be paid in instalments depending mainly on the progress of construction (but sometimes also depending on other requirements, such as obtaining the licence, entering into lease agreements, amendment of the building permit, etc.). The last instalment will usually be paid after the usual requirements for the purchase price to be due (registration of the priority notice of transfer; removal of encumbrances from the land, etc.) and after the (main) tenant has taken over the object of the lease (and preferably paid the first rent without reductions) have been fulfilled.

In this case, the developer has the advantage that he needs little or no bank financing, while the buyer – in addition to a higher return – assumes the risk of insolvency and the general risk inherent in construction.

To minimise the risk on the buyer-investor side, not only the due diligence process has to be more detailed but also the sale and purchase agreement has to provide for certain security mechanisms: the seller’s insolvency risk has to be covered; termination rights, if possible, backed by guarantees for the repayment of instalments paid so far, etc. and mechanisms have to be in place to ensure that the requirements for the different instalments of the purchase price can be objectively verified.

The EU Next Generation Plan and its implementation in Spain

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To address the severe crisis caused by the Covid-19 pandemic, the European Union proposed a temporary recovery instrument, the Next Generation EU Plan, endowed with €750 billion. This historic amount will be channelled to member states in two tranches: €390 billion in grants and €360 billion in loans.

These funds aim to rebuild the European economy after Covid-19 and make it more sustainable, digital and resilient. Spain has the option of accessing 140 billion euros, of which 72 billion will be non-refundable. For the time being, the Spanish government will only ask for these 72 billion euros allocated in direct aid. The mobilisation of these funds will be concentrated in just three years, in the period 2021-23, in order to maximise their impact on the rapid reconstruction of the economy, while the loans will serve to complement, subsequently, the financing of the projects underway. In addition to all these funds, €79 billion will be provided by the structural funds and the Common Agricultural Policy for 2021-27.

Spain will distribute Recovery Plan funds in three ways:

  • The Strategic Projects for Economic Recovery and Transformation (PERTE): a new form of public-private collaboration that identifies structural projects with a great capacity to boost growth, employment and competitiveness of the Spanish economy. The first PERTE to be published is the Electric and Connected Vehicle.
  • Subsidies, for the financing of public assets, through competitive calls for proposals. They require public-private financing.
  • Contracts, for the financing of public assets, through tenders. Financing can be 100% public or public-private (concessions).

In July 2021, the Council of Economic and Finance Ministers (ECOFIN) definitively approved the Spanish Recovery Plan, and a few weeks later the Spanish government received the first €9 billion. Among the many specific measures included in the Recovery Plan are to digitise more than one million SMEs, support more than 3,000 companies in their internationalisation, train more than 2.6 million people in digital skills and deploy plans to promote female talent, or install more than 240,000 interactive digital classrooms.

ESG strategy, key for medium-sized companies

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The Sustainable Development Goals (SDGs), adopted by the United Nations in 2015, cover areas such as responding to the threat of climate change, eradicating poverty, promoting gender equality and social inclusion, among others. The SDGs propose a plan to move towards a global economy that is much more responsible and inclusive of people and the planet.

The investment world, with funds that invest in companies at the forefront, is aware that it must collaborate decisively in the achievement of these SDG objectives, and it does so by applying the so-called ESG principles (E for Environmental, S for Social and G for Governance). These are non-financial criteria divided into three main groups:

  • The environmental ones, which encompass aspects such as climate change, toxic emissions or renewable energies;
  • Social criteria, such as the achievement of human rights, decent working conditions, equal diversity and access to information;
  • Corporate governance, such as putting an end to corruption, promoting business ethics or fostering transparency.
ESG criteria. Source: Rankia

Increasingly, pressure from the investment world and society in general will mean that companies will have to submit to these ESG principles if they want to obtain financing from the markets and their agents (banks, funds and investors in general). The Next Generation funds, for example, will have a strong ESG component, and more and more funds with which we collaborate at Altria Corpo are setting ESG criteria for financing medium-sized companies.

The ESG strategy is therefore absolutely crucial for companies in the coming years and is transformational in all areas of the company, so the responsibility for implementing it lies with the general management and governing bodies, and is not a matter that should be left to the marketing and communications department alone.

Altria Corpo, through its partnership with the leading PKF Attest group, can help companies to undertake the necessary ESG transformation processes from all sides:

  • Definition of the ESG strategy, with the help of specialist strategic consultants.
  • Participation in the implementation of the plans that have been defined: emission control plans, compliance, equality, conciliation, supplier management, etc.
  • Measurement of the company’s progress over time based on objective ESG indicators, and benchmarking with companies in the sector.
  • Support in obtaining an ESG certificate such as the B Corp certificate, among others.
  • Implementation of Business Intelligence solutions to measure and track ESG KPIs.
  • ESG audits

How to finance with the new Productive Industrial Investment Support Fund (FAIIP)?

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One of the novelties for 2021 is the creation of the Productive Industrial Investment Support Fund (FAIIP), with an endowment of 600 million euros, aimed at providing returnable financial support to promote industrial investments. The management of the FAIIP has been entrusted to SEPI Desarrollo Empresarial, S.A., S.M.E. (SEPIDES).

Therefore, all Spanish companies that develop or will develop a productive industrial activity and industrial services, regardless of their size, may be beneficiaries of this fund. The projects must be located in the national territory, being eligible for funding, for applications submitted in 2021, both items that have been executed since 1 July 2020, as well as those that are executed up to 2 years after the date of formalisation of the financing of the FAIPP Fund. For new projects, not yet started, the start of their implementation must be foreseen within a maximum period of 12 months.

There are three financing formulas: ordinary loans, participating loans, temporary and minority equity participation, or mixed formulas between the above, with long-term operations (up to 10 years) and high grace periods (up to 3 years in ordinary and participating loans).

Interest rates will depend on the rating of the company and type of project, the type of financial operation, and the bonus that may be established for compliance with industrial impact criteria, within the following ranges: between 1 and 4.5% for ordinary loans; between 4 and 7.5% in equity loans; and between 4.5 and 8% in equity participation.

The eligible amount of each operation is up to 75% of the project’s bankable budget, with operations ranging from 200,000 euros to 60 million euros per year.

Altria Corpo has direct contact with SEPIDES and can help industrial companies in advising and processing the best financing solution, both under this new FAIIP, as well as in the multiple alternatives that exist from alternative financing.

How will Covid-19 public financing be renegotiated with the banks?

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Last May 2021, the Secretary of State for the Economy and Business Support approved the Code of Good Practice for the renegotiation of financing guaranteed by public entities (ICO, CESCE or CERSA) on the occasion of the Covid-19 crisis.

Thus, companies that received aid in the form of bank financing guaranteed by these public entities will have the possibility to apply for one of the 3 measures made available to them:

  1. Extension of ICO loans: for two more years, so that the maximum term for loans of less than €1.8 million will be 10 years, and for loans of more than €1.8 million it will be 8 years. This extension will be mandatory for banks in cases of a decrease in sales of more than 30% in the period 2020 compared to 2019, and only optional if the decrease in turnover is less.
  2. Conversion of the financing into a shareholder loan, with maintenance of the public guarantee: in this case, a decrease in turnover of more than 30% is mandatory and the company must also have recorded losses in 2020. The refinancing of the guaranteed debt will be binding for all banks, when more than 50% of the guaranteed nominal amount supports it.
  3. As a measure of last resort, the reduction (write-down) of the principal of the financing by means of transfers by the State.

All these modalities will be implemented in the framework of an agreement to renegotiate the debt of all banks, making their best effort to include both the secured and unsecured part, generated between 3/17/20 and 3/12/21.

One or more measures may be implemented at the same time or successively. In order to coordinate the whole process between the various financial institutions, it has been stipulated that the bank with the highest risk ICO will be the coordinator of all the banks, and the company must contact it. Tranches 1 and 2 must be communicated to ICO before 12/1/21, and tranche 3 before 12/1/22. Debt secured by collateral or guarantors is excluded from these coordination rules.

Another very important point to bear in mind is that, if any of these three modalities are used, the banks undertake to maintain the working capital lines until 12/31/22. And as far as the refinancing of the non-guaranteed debt is concerned, the unanimity of all the financial institutions will be necessary.

For more details on the eligibility criteria and how the whole process works, please contact us. At Altria Corpo we can handle all these procedures and negotiations with financial institutions, as well as look for all kinds of additional financing solutions from among the more than 100 alternative financing providers to which we can provide access.