Securing financing is one of the most critical aspects of any real estate investment or development project. Yet, in today’s market, the question is no longer simply whether a project is “bankable.” A more accurate question is: Is the project fundable?
The lending landscape has evolved significantly. While banks remain an important source of financing, private debt funds and alternative lenders are playing an increasingly prominent role, offering developers more flexibility and, in many cases, higher leverage.
So, what determines whether a real estate project can attract financing?
The Core Principle: Risk and Return
At its heart, funding decisions come down to one question:
Will the lender get their money back?
To answer this, lenders assess two primary risks:
- Asset Risk – Is the real estate asset likely to maintain or increase its value?
- Sponsor Risk – Does the borrower have the experience, credibility, and capability to execute the project successfully?
Every financing decision revolves around a project’s risk-return profile and whether it aligns with the lender’s investment criteria.
Banks vs Private Debt Funds
Banks continue to be highly relevant because they generally offer the cheapest source of finance. However, they are also highly conservative.
Typically, banks:
- Prefer lower loan-to-value (LTV) ratios
- Focus on stabilised assets with secure income streams
- Have stricter underwriting criteria
Private debt funds, meanwhile, often:
- Offer higher leverage
- Finance more complex transactions, including development and land acquisition
- Take on greater risk in exchange for higher returns
For smaller developers, private debt can significantly reduce the equity required to complete a project.
Case Study: Prime London Office Investment
Consider a prime office investment at 21 St James’s Square, London.
The property features:
- Prime Central London location
- Freehold ownership
- Fully let building
- Strong tenant covenant
- Long-term lease structure
On paper, this appears to be an ideal investment. However, fundability goes beyond simply owning a prime asset.
Lenders will immediately examine:
- The strength of the tenants
- Lease lengths and break options
- Future vacancy risk
- The sustainability of rental income
Even exceptional assets become riskier as lease terms shorten and tenant break dates approach. As these events draw nearer, lenders may become increasingly cautious about financing or refinancing the property.
Why Tenant Covenants Matter
The quality of tenants significantly influences lending decisions.
Strong, established tenants with proven financial strength provide lenders with confidence that:
- Rent payments will continue uninterrupted
- Default risk remains low
- Future cash flows are more predictable
For lenders, secure income streams reduce uncertainty and improve the overall risk profile of an investment.
Understanding Investment Returns
A common mistake investors make is focusing solely on asset quality while overlooking returns.
In the case study, the investment generated an ungeared Internal Rate of Return (IRR) of approximately 4.4%.
This creates a challenge.
If borrowing costs exceed the asset’s expected return, financing simply does not make economic sense.
For example:
- SONIA rate: approximately 3.75%
- Lending margin: approximately 2%
- Total borrowing cost: approximately 5.75%
When borrowing costs are higher than the project’s expected return, investors would systematically lose money by using debt.
In such circumstances, the asset may still appeal to investors seeking capital preservation, but it becomes significantly less attractive as a leveraged investment.
The Two Key Questions Every Lender Asks
1. Can the Project Service the Debt?
Lenders assess whether rental income can comfortably cover interest payments and any principal repayments.
This is measured through:
- Debt Service Coverage Ratio (DSCR)
- Interest Coverage Ratio (ICR)
If rising interest rates cause these ratios to deteriorate, the borrower may breach lending covenants and need to inject additional equity.
2. Can the Loan Be Repaid at Exit?
Lenders also examine:
- Exit values
- Future capital values
- Loan-to-value ratios at repayment
If property yields soften and values decline, the asset may no longer be worth enough to repay the outstanding debt.
Even when an investment generates stable income, falling valuations can significantly increase refinancing risk.
Fundability Is More Than Financial Modelling
Financial models are important, but lenders evaluate much more than spreadsheets.
They continuously monitor factors such as:
- Vacancy levels
- Capital expenditure requirements
- Asset management plans
- Market conditions
- Lease events and tenant movements
Ultimately, lenders need confidence that both the income and underlying asset value will remain strong enough to protect their investment.
The Importance of Financial Modelling Skills
As artificial intelligence becomes increasingly integrated into financial analysis, the ability to understand and interpret financial models remains essential.
AI can accelerate analysis and generate models quickly, but professionals still need to:
- Understand the underlying assumptions
- Validate calculations
- Identify errors and inconsistencies
- Adjust models based on changing market conditions
Technology can enhance decision-making, but expertise in real estate finance and financial modelling remains indispensable.
Final Thoughts
A project is not fundable simply because it is a prime asset or generates rental income.
A fundable project is one where:
- Risk and return are appropriately balanced
- Income comfortably supports debt obligations
- Exit values can repay capital
- The sponsor demonstrates capability and credibility
- The investment aligns with lender requirements
In today’s market, understanding these fundamentals is essential for investors, developers, and finance professionals seeking to structure transactions that can successfully attract capital.
