Financing property
Financing property generally involves three main participants. The developer or borrower creates the property asset normally using short term finance from a commercial or merchant bank, whereas long term finance is usually provided by an institution .For the borrower the optimum form of financing represents, ceteris paribus, the most preferred way of raising capital, whereas for both short and long term investors it is the best way of using capital .
Short and long term finance reflects the two main stages in the development process .The two stages display different degrees of risk and therefore require different types of finance . The construction stage is relatively short, generally lasting from two to five years . Short term finance is required for the construction period and is generally available for a maximum of three years .The limited security of the incomplete building means that such finance may be relatively expensive, although the actual rate of interest depends on the financial status of the developer and the quality of the scheme .The developer will try to minimize the construction period to reduce interest charges.At the end of the development period the property may be sold and a profit realized, or it may be refinanced on a long term basis if the developer wishes to retain it as an investment .A successful developer will wish to retain some of the better developments as collateral and income against future borrowing .The main sources of short term finance are the commercial banks, merchant banks and United Kingdom subsidiaries of foreign banks.
The second stage comprises the sale or letting of the property over the long term period of the economic or physical life of the building .Long term finance is secured on the completed building and is therefore less risky .Traditionally, the margin between interest payable and rental income provides an indication of the security of the loan .Long term funding is therefore normally less expensive than short term finance .The main providers are the pension funds and life insurance companies who have long term liabilities and have come to dominate the property investment market .
The short and long term financing scenarios are also found in those sectors of the market characterized by owner occupation ; for example, residential property. The developer, on the basis of a short term loan, usually from a bank, builds the houses which are then sold to occupiers who finance their purchase by taking out a mortgage, usually from a building society .Although building societies are not allowed to be house builders, they have promoted development in inner city areas.
The revolution in financing property has produced financial mechanisms which have bridged the gap between short and long term capital markets .However, there are dangers in utilizing short term credit over the longer term. Problems of illiquidity or cash flow difficulties may result in the stopping of short term credit, so leaving the developer with the problem of repayment.
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