Chirayuthchai TraisaengsatheanStrategic Finance for Property Development

Funding stack from equity to exit

Each layer of money bears a different level of risk, comes in at a different time and exits by a different route, with the effect of leverage on Equity IRR

Key takeaways

  • A funding stack arranges each tranche of money by the rank of risk it bears, when it comes in and how it exits. It is not a list of funding sources.
  • Funding falls into 5 groups: bank debt, debt instruments, equity and quasi-equity, project cash, and new alternatives. Each group suits a different stage of the project.
  • Leverage magnifies both profit and loss. In the example, 75% debt gives an Equity IRR of 39.8% when Project IRR is 18%, but -1.8% when Project IRR falls to 5%.

A stack is an order of risk-bearing

Every project has layers of money stacked on one another. When cash comes in, the upper layers are paid first; when losses occur, the lower layers bear them first. This order is why each layer has a different cost: those who bear more risk naturally demand a higher return.

Order of repaymentTypeExample
1Senior SecuredProject loan secured by a first-ranking mortgage
2Senior UnsecuredUnsecured revolving facility
3SubordinatedMezzanine Loan
4Preferred EquityInvestors' preference shares
5Common EquityCore shareholders' equity

Where there are several layers of creditors, an Inter-Creditor Agreement is needed to set the order of repayment, the period junior creditors must wait before enforcing their rights (Enforcement Standstill), voting rights, refinancing rights and information sharing.

5 groups of funding sources

The costs in the table are approximate ranges for comparison. Actual costs depend on the company's credit and market conditions.

GroupToolsApproximate costMain constraints
A. Bank debtTerm Loan, Construction Loan, Bridge, O/DAbout 6–10% a yearSecurity, DSCR, LTV and strict approval
B. Debt instrumentsPrivate Bond, Promissory Note, Debenture, SecuritizationAbout 7–12% a yearMore flexible, but subject to SEC rules
C. Equity and quasi-equitySponsor Equity, JV, Preferred Equity, Fund/TrustExpected return of 12–20% or moreNo fixed repayment burden, but ownership is shared
D. Project cashPresale Cash Flow, Supplier/Contractor CreditNo direct interest, but there are hidden costsDepends on sales and bargaining power
E. New alternativesInvestment Token, Crowdfunding, REIT, Green Bond, Private Credit, Strategic InvestorVaries by instrumentSpecific criteria, size or complexity

In risk terms, mezzanine sits between senior debt and equity. Although it is a loan, it costs more than senior debt and should be placed in a lower layer. Do not count it together with bank debt when assessing risk-bearing capacity.

A. Bank debt

ToolsCharacteristicsSuitable forPoints to watch
Term LoanBorrowed as a lump sum, repaid in instalments, securedProjects with clear cash flowDSCR, LTV, EIA and security conditions
Construction LoanDrawn down according to construction progress per the S-curve; interest is paid only on the amount drawnConstruction stageWork must meet each progress milestone
Bridge LoanShort-term borrowing to bridge the time until the next lump sumBefore refinancing or while waiting for Presale moneyHigh interest; should be used short term
Mezzanine LoanSubordinated debt, which may be convertible into sharesFills the gap between senior debt and equityHigher interest than senior debt
OverdraftOverdraft facility, paid according to usageShort-term working capitalNot suitable for long-term use

B. Debt instruments

ToolsCharacteristicsSuitable forPoints to watch
Private BondOffered to selected investors; the issuer can set the coupon and tenorLarge sums that need flexibilityMust meet the SEC's private placement criteria
Promissory Note, B/EShort-term notes that can be issued quicklyWorking capital or a short bridgeA public offering may fall under SEC criteria
DebentureSecured or unsecured debentures; broader than a PPCompanies with good creditUsually need a rating and full filing
Securitization, Future-flowConverts future cash flow into a lump sumAssets with regular incomeComplex structure, high set-up cost

There are several private placement channels for debentures, such as PP-10, institutional investors and high-net-worth investors. Each has different conditions on investor type, number of investors, filings and the debenture holders' representative, and the criteria are revised from time to time. Check the SEC's latest announcements with a financial adviser and a lawyer before issuing the instrument.

C. Equity and quasi-equity

ToolsCharacteristicsAdvantagesPoints to watch
Sponsor EquityOwner's equity; banks usually ask for 20–40%No debt burden, full controlHighest cost; the owner's money is tied up
JV EquityCo-investment partnersShares the risk; brings capital and know-howControl is shared; the contract must be clear
Preferred EquityReceives a return before ordinary sharesMore flexible than debtCosts more than debt
Real Estate Fund, TrustSell assets into a fund and lease them backReleases tied-up capital and returns a lump sumSet-up cost and complexity

D. Project cash

ToolsCharacteristicsAdvantagesPoints to watch
Presale Cash FlowBooking deposits, contract deposits and down payments from buyersNo direct interestSlow sales create a gap; there is a risk of cancellations and refunds
Supplier, Contractor CreditTrade credit from suppliersReduces the cash needed during constructionThe cost is often hidden in the price

E. New alternatives

ToolsSuitable forPoints to watch
Investment TokenRetail fundraising in small unitsIssued through a licensed ICO portal under the Digital Asset Emergency Decree 2018
Real Estate CrowdfundingSmall to medium projectsLimited amount; must use a licensed platform
REIT, Property FundExit: assets with regular incomeMust reach sufficient size; complex to set up
Green, Sustainability BondGreen buildings, clean energyRequires a framework and an external review
Private CreditWhen banks are not yet lending but the project has potentialHigher interest than banks
Strategic InvestorProjects that need a brand or know-howRights and profits are shared; negotiation is complex

Comparing instruments by phase

ToolsCostSpeedFlexibilitySecurityPhase
Sponsor, JV EquityHighestSlowHighNot requiredGet Started
Presale Cash FlowLow; hidden costsFast if sales are goodModerateNot requiredConstruction and sales
Term, Construction LoanLow to mediumSlow because approval is requiredModerateRequiredConstruction and long term
Private Bond, DebentureHighModerateHighCase by caseLarge sums
Promissory NoteMediumFastMediumNot necessaryShort term
MezzanineHighModerateHighPartial; subordinatedGap filling
Fund, TrustLow after exitSlowLowThe asset itselfExit and long term

How much debt is appropriate

DimensionDebtEquity
CostLowerHigher
TaxInterest is tax-deductibleDividends are not deductible
Cash flowMust be paid on scheduleNo mandatory payment
Risk to the companyHigh; default is possibleLow
ControlNo direct impact, but covenants applyDiluted
On liquidationPaid firstPaid last

The proportions seen in practice depend on the certainty of cash flow, the quality of security and market conditions. The following ranges are a reference framework based on experience, not bank criteria.

Project typeD/EDebt to total capital
Mid-market condo2.0–3.0x65–75%
Luxury condo1.5–2.5x60–70%
Villa, Branded Residence1.0–2.0x50–65%
Hotel Development2.0–3.0x65–75%
Wellness Resort1.0–2.0x50–65%
Large mixed-use1.5–2.5x60–70%
Assets with steady income2.0–4.0x65–80%

Leverage magnifies both ways

Example A project that invests everything on day one, is held for 4 years and is then sold in one lump sum. Debt accrues compound interest and is repaid at the end; tax is excluded.

Debt %InterestEquity IRR when Project IRR is 18%Equity IRR when Project IRR is 5%
0%—18.0%5.0%
30%6.5%22.0%4.3%
50%6.5%26.9%3.4%
65%6.5%33.2%2.0%
75%7.0%39.8%-1.8%
85%8.0%51.1%-20.8%

Real projects draw down gradually and receive money in several instalments, so the figures differ from this. Use it only to see the direction.

A commonly used range is debt of 60–70% of total cost. In a risky market, reduce it to no more than 60% and set aside an equity reserve of 10–15% of total cost. Experience from the 1997 crisis and Covid-19 points the same way: developers with debt above 80%, no reserve and a low DSCR often cannot withstand sales that are 20–30% slower.

What WACC is used for

WACC = (E/V × Re) + (D/V × Rd × (1 − T))

Example Equity THB 600 m, debt THB 1,400 m, total THB 2,000 m, Re 18%, Rd 6.5%, tax 20%

WACC = 30% × 18% + 70% × 6.5% × (1 − 20%) = 5.40% + 3.64% = 9.04%

A WACC of 9.04% is the minimum floor a project must achieve so as not to destroy value. The hurdle rate for a development project should be higher, to compensate for construction and sales risk.

Modigliani-Miller theory says that in an ideal world capital structure does not affect value, and that when taxes exist, interest adds value through the tax shield. But the real world has bankruptcy costs, agency costs, information asymmetry and transaction costs, so debt should not be as high as the most you can borrow.

A stack ends at exit

Every stack must answer what money will repay the debt and when the equity comes back

ChannelSuitable sizeFundraising costTimeEffect on control
Bank LoanUnder THB 2,000 m0.5–1%3–6 monthsLow; covenants apply
Private PlacementTHB 500–3,000 m1–2%3–4 monthsModerate
Corporate BondOver THB 1,000 m1–3%4–6 monthsLow
REITOver THB 500 m3–5%9–12 monthsMedium to high
IPOOver THB 1,000 m5–10%18–36 monthsHighest
CrowdfundingUnder THB 100 m3–7%2–4 monthsLow
  • Projects sold to buyers: debt is repaid from transfer proceeds and the release price.
  • Assets held long term: switch from a construction loan to post-finance once income stabilises.
  • Assets with regular income: consider selling into a fund or REIT once the size and eligibility criteria are met.
  • Bonds need a refinancing plan well before maturity.
  • An IPO suits a company that needs liquidity and has governance in place; it is not necessary for every company.