Andrew Screen: Aiming high to build a framework for funding

The story so far: banks are not taking on higher-risk projects, and have increased the cost of funding. What's more, the amount of funding they are prepared to provide has dropped - along with the amount of time over which they are willing to lend. Add to that the reluctance of investors to invest in banking products and the lower interest rates offered to savers and you have an even smaller pot of money for banks to draw upon.

There has been a significant reduction in central government funding for new projects and this has all but ended the supply of Public Private Partnerships (PPP) and Public Finance Initiative (PFI) credits, a collapse that has created difficulties for larger schemes that have already been signed off.

All of this spells trouble for local authorities where they wish to fund projects from their own resources, and in the increased cost of funding for deals that are still to be completed.

Yet equity markets have significant cash holdings. After all, people continue to pay into their pension funds. Equity funds and sovereign wealth funds are also holding cash that has not been spent over the past two years. However, equity investors are willing to invest at the bottom of the market where prices are lowest and are looking for lower-risk projects before they will invest.

But how can they invest? New tools are needed to unlock this investment Since the collapse of the funding markets, new ways of funding and structuring projects need to be found to allow them to attract equity investors and for construction to begin. Property consultancy GVA's new Funding Toolkit investigates these new options. The toolkit brings together a variety of funding methods and financial structures to inject momentum into development, regeneration and infrastructure projects. It uses public and private funding, as well as joint venture funding. It examines how these funds are repaid; while reducing risk to attract banks and investors.

Sources of funds for capital projects (whether building roads, rail, schools, energy plants or housing) divide into public sector, private sector and public/private sector funds.

Traditionally, projects were either funded by developers and banks, or by the local authorities who borrowed from the government. However, few developers now have the money to fund these projects and the banks have little appetite for development risk (particularly housing).There has been an increase in local authorities willing to lend money to developers to undertake projects, as authorities can source funding at a lower cost than the banking sector and this can provide an efficient use of funding for public works and infrastructure.

Providing the right risk profile and funding structure is available, the private sector investors are also interested in funding infrastructure, development and regeneration projects. This sector is evolving in response to the collapse of the funding market. Pension and equity funds are setting up ways to provide funding to developers for projects (mainly schools, health, energy and waste) where there is a lower risk. There has also been an increase in public/private funds such as the Joint European Support for Sustainable Investment in City Areas (JESSICA), which is a combination of European funding, public-sector and investor money which is used to fund regeneration projects and improve areas. Developers can apply for loans from these JESSICA funds for projects which are mainly of a commercial and industrial nature. We are seeing more innovative ways of funding projects and are developing structures to encourage the flow of debt and equity funding back into the market.

How the project funding will be repaid is vital, as it can reduce the risk and, therefore, lower the cost of debt and equity finance. The aim is to achieve the most secure repayment method with the lowest risk of failure. This has created a variety of mechanisms which are currently under discussion by local authorities and developers, including Tax Increment Finance (TIF), charge over land, and development charges.

TIF has been used in the United States for the past 50 years. It involves using the increase in business rates that are likely in an area due to the increase in development, as a funding tool. Local authorities can apply to retain this uplift for a period (usually 25 years), using a portion to fund infrastructure projects. TIF has recently been approved at Edinburgh Waterfront and is under consideration for the Buchanan Quarter in Glasgow and at Ravenscraig.

The charge over land repayment mechanism has been developed by GVA. It's ideal for areas with up to six landowners who need infrastructure on their development site but cannot initially pay for it. The infrastructure is funded by the local authority by way of a loan to the landowners in return for security over the land. This security is released when a payment is made back to the local authority in proportion to the amount of land sold.

A GVA-led team is currently working for the Scottish Government to examine the potential for a development charge model for Scotland, and is due to report its findings this month.

• Andrew Screen is a director at GVA and head of its Financial Consulting Team.