FACTORS AFFECTING COMMERCIAL BANKS’ DECISIONS TO FINANCE RESIDENTIAL REAL ESTATE DEVELOPMENT PROJECTS IN VIETNAM
FACTORS AFFECTING COMMERCIAL BANKS’ DECISIONS TO FINANCE RESIDENTIAL REAL ESTATE PROJECTS IN VIETNAM
Nguyen Huu Dung
Faculty of Real Estate and Resource Economics, National Economics University
Abstract: The purpose of this study is to identify the key factors that a lender considers when financing real estate transactions, as well as the relative importance of each of those factors. The results reveal that the key factors influencing a lender’s decision to finance a real estate transaction include: the projected cash flow of a specific deal, pricing, the lender’s return on equity, the client’s risk rating, the property’s location, the type of property, the borrower’s business nature, collateral, and the relationship with the client.
Keywords: real estate, commercial bank, capital financing.
I. Introduction
The Vietnam Real Estate Association (VNREA) emphasized in 2021 that the current difficulty in accessing capital and financing is prolonging the implementation of many real estate projects. Consequently, projects are being carried out slowly and do not always bring profits or benefits to those promoting them.
Access to capital is a major challenge that hinders the Vietnamese real estate market from becoming attractive and poses an obstacle to the development of the real estate sector. In 2024, three years after the VNREA conference, the Report of the Fourth Meeting of the Executive Committee of the Vietnam Real Estate Association, 5th Term (2022 – 2027) reaffirmed this argument. The report once again emphasized that access to finance is the most challenging factor in doing business.
The 2024 Report of the Vietnam Institute of Economics also pointed out that “access to finance and the lack of adequate financial resources is a challenge to take advantage of the various opportunities existing in Vietnam”. Kim (2020) highlighted that a key feature of the capital market in Vietnam is that bank credit to the private sector remains very low compared to other developing countries.
Faster economic growth cannot occur without the deep development of the financial system, especially the support from the banking system. N. T. P. Nguyen et al. (2017) noted that financial scarcity creates a challenging environment for real estate owners and investors when they decide to conduct transactions using higher equity levels, which are not always available. This situation affects project progress as well as the overall benefits to customers.
Trinh and Mai (2016) discovered that when lending money, the primary task of the lender is to assess their risk level in case the borrower defaults. When presenting a funding proposal to the lender, real estate clients are often concerned with demonstrating the project’s feasibility and frequently neglect to explain appropriate risk mitigation measures for those projects.
Vietnamese banks are very enthusiastic about participating in the real estate market, as confirmed in the study by Nguyen et al. (2023). However, the market shows that access to this capital is rare and seems quite complicated, as concluded at the VNREA conference in 2021.
Therefore, the scarcity in accessing capital has created the objective of this research, aiming to understand the reasons and motivations related to real estate capital provision in Vietnam (from the lender’s perspective), especially in the commercial banking sector.
The results of this study will provide an in-depth view of the important factors a lender considers when providing real estate financing. These findings benefit borrowers or debt initiators by constructing better proposals, which can facilitate access to finance for real estate transactions.
Furthermore, lenders will be able to receive funding proposals that may facilitate approval, thereby increasing the potential for generating greater profits. Finally, strong credit activities will naturally create fixed assets for the nation, meeting the needs for housing and urban, tourism development.
II. Factors Affecting Banks’ Capital Financing Decisions
According to T. B. Nguyen et al. (2017), practical considerations in using debt to finance real estate assets include:
- Ownership structure
- Access to equity markets
- Asset risk
- Bankruptcy costs
- Specific tax regulations and interest rates
Isaac (2003) pointed out that lenders consider four issues in a loan proposal:
– Character (customer): Illustrating the borrower’s experience or transaction history, including their credit history.
– Capital contribution in cash: The origin and amount of capital to be contributed by the borrower in the transaction.
– Capacity: The borrower’s ability to repay the loan.
– Collateral: Assets provided to secure the loan.
Each of these factors is thoroughly evaluated in the loan appraisal process, and they often have additional sub-criteria that need to be assessed.
Additionally, the lending criteria of a bank, according to Cloete (2005), will vary depending on many specific factors, including the size and nature of the company, the nature and scale of the project, the loan term, and the strength of the collateral provided.
Van Thi Hong Pham and Nguyen (2022) stated that in assessing the risk of corporate loans, banks will consider financial strength, real estate assets, operational records, project profitability, and cash flow. The bank will strive to ensure that the assets are well-positioned and that the plan is feasible. Interest rate volatility, repayment, and safety are also emphasized as issues to consider when borrowing money.
Specifically, the anticipated (hypothetical) factors are identified based on the review of previous studies as follows:
- Asset Type
Trang et al. (2022) pointed out that different types of assets have different investment risk levels, and the appropriate discount rates should vary according to the asset type.
Hoang et al. (2021) observed that there are certain characteristics that all assets share (such as planning, usage), and these characteristics provide a mechanism to classify each asset into a type.
According to Anh (2020), assets can be classified into vacant land, agriculture, commercial (retail, office), residential (single-family, multi-unit), industrial (warehouse, factory), special-purpose (schools, churches, hotels), and mixed-use. Lending capacity may vary depending on the type of asset presented in the funding proposal.
- Pricing (Interest Rates and Fees)
Pricing in Ha (2021) is explained as a reflection of potential risks and the attractiveness of a transaction, along with competitive factors. Interest rates are required as compensation for the risk the lender bears when providing money, while fees are charged for incurred costs and services provided.
Thuy and Long (2023) explained that lenders always seek to minimize their risks. In exchange for accepting a higher perceived level of risk, the lender will charge a higher interest rate corresponding to the risk level.
This view is also agreed upon by Nguyen et al. (2024), stating that transactions in emerging markets are priced higher compared to more developed markets, primarily to compensate lenders for the higher levels of risk they bear.
- Collateral
Khoa and Thai (2021) defined collateral as the assurance provided by the borrower to the lender in exchange for capital. Some typical forms of collateral required in real estate transactions are:
– Asset mortgage: Lenders can register a mortgage on land and types of assets attached to the land. Ghi (2016) emphasized that this collateral involves restrictions placed on the ownership certificate, as the property owner cannot transfer or sell the land without first settling the mortgage on the certificate.
– Guarantee or surety: Wang et al. (2020) described that “under a guarantee contract between the lender and a third party, the third party commits to fulfilling the borrower’s obligations under the main loan in case the borrower fails to perform.”
Foryś and Ngoc (2016) further stated that a guarantee is an agreement under which a guarantor voluntarily assumes responsibility to a lender for the proper performance of the borrower’s obligations. This assurance can be diminishing as the loan obligation decreases over time.
– Income assignment: This concept was explained by Havenga and colleagues (2003) as “the transfer of rights under an agreement, between the rights holder (i.e., a creditor) and a third party, so that the third party becomes the holder of those rights.”
Common assignments required by lenders include the assignment of rental income, profits, lease contracts, rights and interests, insurance policies, and debt books. The borrower can pledge the creditor’s rights to the lender or transfer the rights to the lender.
– Commitments: The SAPOA PDP Handbook (2011) explained that guarantors or shareholders of the borrower may commit to covering cash shortfalls related to loan repayments and may pledge to invest capital in any cost overruns in case of development projects.
- Project Cash Flow
Hung et al. (2019) mentioned that lenders with long-term credit terms are often concerned with the borrower’s cash flow ability to repay over a long period. This view differs from commercial creditors (short-term lenders), who are mainly concerned with the borrower’s liquidity.
Lenders assess the borrower’s repayment ability by analyzing their capital structure, main sources and uses of capital, profitability over time, and future profitability projections (Ha, 2022).
In Dao’s (2018) research, the cash flow of a real estate project depends on many factors, all of which are subject to risk. This includes actual revenue and a range of costs. Revenue depends on other risk factors such as the state of the economy, competition, property management expertise, etc.
Hoai and Thanwadee (2015) pointed out that the loan-to-value (LTV) ratio depends on the risk perceived by the bank and can vary significantly based on the borrower’s risk profile, perceived project risk, and the current market at that time.
- Real Estate Location
Each residential area has unique intrinsic characteristics that make it different from other residential areas. Yeh et al. (2023) explained that each area has different risks that banks will consider when approving or rejecting loans. They argued that “these area-specific risks will determine the extent to which banks can lend, as well as the borrower’s capital contribution.”
Investigating the location involves evaluating the property’s utility system (linkages) as well as the advantages and disadvantages the property receives from its location (Nguyen et al., 2019).
- Borrower’s Reputation
Nguyen et al. (2019) described that a bank’s internal rating summarizes the risk of loss due to a specific borrower not repaying as promised. They also mentioned that the credit risk for a loan or another exposure over a certain period includes both the probability of default (PD) and the percentage of the loan’s value likely to be lost in the event of default (LIED). The product of PD and LIED is the expected loss (EL).
In Wight’s (2001) study, it was explained that the main purpose of allocating risk levels is to categorize the risks associated with the bank’s loan portfolio, with each loan being assessed for its risk level. The risk level is determined based on the borrower’s profile, income sustainability, loan-to-value (LTV) ratio, type of property, location, and quality of the property. Each factor is rated (usually from 1 to 5, with 1 being high risk and 5 being low risk) and weighted. The weighted score is then used to classify the risk for the transaction.
Research conducted by Le (2016) mentioned that banks’ rating systems differ from agencies, partly because internal ratings are assigned by bank staff and are often not disclosed externally. The overall goal of risk classification is to determine the customer’s repayment ability and credit reliability.
- Borrower Relationships and Communication
In the financial services industry, where human interaction is very high, relationships and personal communication are especially important and can make the difference between success and failure (Nguyen et al., 2021). Even a country’s value system and its people determine how a company will operate.
Nguyen et al. (2022) cited that a trust-based relationship creates advantages in conducting business, such as reducing costs, shortening processing times, and improving service delivery performance.
According to Phan et al. (2022), real estate financing transactions often lead to long-term contracts, requiring the development of relationships between lenders and borrowers and being subject to social pressures such as colleagues, acquaintances, or social networks.
Matveeva et al. (2018) noted that relationships can be formed, maintained, and terminated. Lending decisions sometimes depend on those relationships.
- Macroeconomic Policies
Tuan and Trang (2020) suggested that economic conditions such as inflation, interest rates, GDP growth, as well as monetary and fiscal policies, are important and affect the potential risk and profitability of the industry.
These factors can be classified as external factors, as lenders do not have direct control over them. The significant depreciation of the VND and the ability to convert this currency into US dollars is a potential risk (Kim, 2019).
Large fluctuations in these factors can make a specific asset in a specific market less attractive and thus can influence the bank’s capital financing decision.
III. Conclusion and Recommendations
Project cash flow is considered the most influential factor in real estate financing decisions. Lenders primarily focus on the repayment ability of a transaction proposal before considering other factors. If the repayment ability is comfortably demonstrated early in the borrowing process, there will be more interest in providing capital for a proposal, thus facilitating access to finance.
Pricing and the lender’s profit margin are ranked as the second and third most influential factors, respectively. Borrowers need to be able to generate sufficient profit for the lender, surpassing even the borrower’s own profit. Banks operate with the goal of generating profit, so if a funding proposal can demonstrate profitability feasibility for both the bank and the borrower, interest in the lending transaction will be enhanced.
The location of real estate is ranked as the fourth influential factor. A poorly located property can reduce access to capital despite its rental profile. However, in cases of lacking infrastructure and amenities, the influence of location plays a larger role.
Customer risk rating ranks fifth. This is driven by the lender’s internal policies and systems, and the results show that such classification can be improved by demonstrating repayment ability and credit reliability.
The classification of property types is the sixth influential factor. If a property has a specialized nature, the borrower can facilitate access to capital by leasing the property to strong tenants.
The seventh influential factor is the nature of the borrower’s business. As long as the borrower can demonstrate repayment ability, the influence of this factor is negligible.
Collateral provided as a security for a transaction is ranked as the eighth influential factor. The relevance of this factor becomes more significant if the collateral provided can quickly be converted into cash, contributing to debt repayment.
Customer relationships rank as the ninth influential factor. While relationships can be the difference between success and failure, the advantage of relationships is that loan processing times can be improved, and generally, the costs associated with providing a loan can also be reduced.
Other factors mentioned as influential include the borrower’s experience and credit history, as well as the loan terms. It has also been noted that the relative importance of the main influencing factors depends on the bank’s internal lending policies, and the real estate cycle also plays a role in influencing the importance of these factors.
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