The Precarious Issue of Residential Development Financing : A Medium Sized Developer’s Troublesome Reality

Abstract: Residential real estate development is a capital-intensive business with a lot of risks involved, particularly according to Swedish banks. Since the price fall and decreased consumer confidence on the housing market in 2017, banks have become considerably more restrictive with regards to their approval of construction credit, especially towards smaller and medium sized actors on the residential real estate development market. Due to this restrictive lending environment, small and medium sized developers are often forced to utilize equity capital to an extent that is unlikely to be optimal with regards to modern capital structure theories. The aim of this research paper was, therefore, to explore the financing issues within the sector, examine the financing options available to Swedish medium sized residential developers, and conclude what could be conducted differently by both financiers and developers within the sector to potentially resolve the suggested issue.  The method chosen to explore and examine the selected subject area was semi-structured interviews with highly experienced employees of medium sized developers located in Stockholm, Sweden, Swedish commercial banks and other alternative financiers active within the sphere of residential real estate development financing. The rationale behind involving both developers and financiers was to gain an understanding of the issue from different perspectives, and thus hear arguments and counter arguments for and against the current financing structure in order to find the most suitable potential improvements. The collected data from the interviews was thematically analyzed and discussed from a perspective of modern and established financial theory, such as the trade off theory and the pecking order theory, along with other relevant theoretical frameworks, such as anchoring, game theory and risk. What was found was that developers primarily have an issue with early project financing and moving capital efficiently between finished and starting projects. Paradoxically, it seems unlikely that developers currently operate in accordance with aforementioned established financial optimization theories due to them being financially conservative in an effort to signal financial strength to banks and be approved construction credit as a reward. Also, what was found was that there exists a lack of effective communication between banks and developers with regards to the development process and accompanied risks, leading to an even more restrictive bank due to the effects of asymmetric information. A potential improvement to the way in which developers currently structure their capital was suggested to be an involvement of alternative financiers in the short term in order to gain access to capital in the more sensitive stages of the development process, later refinancing the debt when possible, through the means of the traditional banking system.