Project financing is a loan structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights, and interests held as secondary collateral. Project finance is especially attractive to the private sector because companies can fund major projects off-balance sheet (OBS).
Real estate project finance is a classic example. Real estate project finance cash flows should be sufficient to cover operating expenses and to fund the financing repayment requirements. Typically, the financing is made up of debt and equity matched to the lifespan of the asset.
When it comes to funding real estate project finance, the capital stack includes several considerations, as follows:
- Draws on construction loans for financing
- Security and priority for various lenders in the capital stack
- Term that matches the length of time it takes to develop and sell the project
- Trade-offs between fixed and floating interest rate
- Pricing around the equity
The capital stack, which consists of all of the different types of financing that may be used, typically comprises the following:
- Senior debt
- Subordinated debt
Senior debt is the most secured capital, while equity is the riskiest out of the three.
Source: Corporate Finance Institute