Collaboration Deals between SMEs and their House Banks to Improve SME Finance

12.12.2012 University of Groningen

Master Thesis

MSc Business Administration Small Business Management and

Entrepreneurship

Collaboration Deals

between SMEs and their

House Banks to

Improve SME Finance

The Case of Real Estate

Project Development

Abstract

Purpose – The purpose of this thesis is to examine whether it is possible to improve access to external

finance for small real estate project developers by establishing collaboration deals with banks, which are of mutual benefit. Banks are supposed to be incentivized to enter those collaboration deals by (1) the offer of a powerful marketing instrument for their mortgages, (2) brokerage fees and (3) pre-emption rights for the properties of the developer they are requested to finance. The offer of these three incentives is expected to decrease transaction costs of the banks.

Methodology – Explorative case study involving expert interviews with different representatives of the

banking sector.

Findings – Only incentive 1 is identified as a business opportunity. Incentive 2 and incentive 3 had to be

dismissed. Incentive 1 has only a minor positive impact on search and information costs. A collaborative approach led to possible economies of 7,5 work hours for a relatively small project and to economies of 24,5 work hours for a relatively large project. Relationship banking has only a very moderate positive effect on assessment costs of banks as well. Access to and conditions of finance for SMEs are not affected by the three incentives.

Research limitations – No academic literature was available dealing with these kinds of collaboration

deals between SMEs and financial intermediaries. Banks are generally closed organizations that do not share information.

Implications – Possible transaction cost economies for banks only start to become profitable if very large

projects are developed. The questioned banks rather identified the marketing instrument related to incentive 1 as rewarding, but it does not lead to improved access to external financing for small real estate developers either.

Keywords – Small business management, small business finance, entrepreneurship, relationship banking,

real estate management, real estate finance, transaction cost economics and strategic banking.

I

Table of Content

The underlying problem ... 1

1.1 Acknowledgement of previous work and use of literature ... 1

1.2 Purpose of the thesis ... 2

1.3 Research questions ... 4

1.4 2 Theoretical framework ... 5

Small and medium-sized enterprises and real estate development ... 5

2.1 2.1.1 Definitions ... 5

2.1.2 Characteristics ... 6

2.1.3 Real estate project development ... 7

The process of financing real estate development... 8

2.2 SME finance ... 10

2.3 The relationship between SMEs and banks ... 12

2.4 2.4.1 Features of relationship banking and its effects ... 13

2.4.2 Relationships and the size of banks and firms ... 14

2.4.3 Tendencies and possible future developments regarding bank - small business relationships ... 15

Possible incentives for banks to enter collaboration deals ... 16

2.5 2.5.1 How are banks earning money? ... 16

2.5.2 Growth strategies of banks ... 16

2.5.3 Opportunity identification... 18

2.5.4 Transaction cost economics ... 20

Research model ... 23

2.6 3 Methodology ... 24

4 Findings and discussion ... 26

II Do incentive 1, incentive 2 and incentive 3 lead to decreasing transaction costs for the 4.2

banks? ... 28

What is the effect of relationship banking on the transaction costs of the banks? ... 33

4.3 How is access to and conditions of finance for SMEs affected by the three incentives and 4.4 their influence on the bank´s transaction costs? ... 36

5 Conclusion ... 38

References ... 41

III

Abbreviations

EU European Union

SMEs Small and medium-sized enterprises

Figures

Figure 1 The process of making real estate lending-borrowing decisions ... 9

Figure 2 Opportunity systematization ... 19

Figure 3 Research model ... 23

Tables

Table 2 SME definition Bolton Report ... 5

Table 3 SME definition EU ... 6

Table 4 Opportunity valuation ... 20

Table 5 Respondents ... 24

Table 6 Data gathering ... 25

Table 7 The two exemplary construction projects ... 30

Table 8 Results from the second interview round... 32

1

1 Introduction

This thesis investigates whether it is possible to increase access to external finance for small real estate project developers by establishing close relationships with banks and thus negotiate so called ration deals, which are of mutual benefit. Banks are supposed to be incentivized to enter those collabo-ration deals by (1) the offer of a powerful marketing instrument for their mortgages and (2) brokerage fees and (3) pre-emption rights for the properties of the developer they are requested to finance. The offer of these three incentives is expected to decrease transaction costs of the banks.

The underlying problem

1.1

The availability of finance for small and medium-sized enterprises (SMEs) is a topic of significant research interest in the academic society, but also an important issue for policy makers around the world (Berger & Udell, 2006).

Especially small and new firms have certain disadvantages in comparison to large established compa-nies regarding the acquisition of financial resources. The reason for this is that the problems of infor-mation asymmetry and uncertainty are much more pronounced in the case of small and young firms (Scholtens, 1999).

This thesis focusses on the real estate project development sector, which makes overcoming financing problems even more important. This is not a regular small business sector, since it is really capital intensive (Sirmans, 1989). It is highly important to find new solutions for resource constrained small firms working in this specific sector to first of all facilitate access to financing and secondly improve conditions of loans. The process of real estate project development continuously requires significant amounts of financial capital and the acquisition of financial resources is a serious problem for smaller companies working in this industry. One of the major difficulties is that banks and project developers have divergent perceptions regarding risk minimization. Banks often require a certain marketing stage of the project (e.g. 50 % of the apartments sold) before the loan funds are activated. This prolongs the realization of the project and makes it more expensive. In addition, selling is very complicated and sometimes impossible by only referencing to planning documents. Thus, project developers on the other hand prefer the fastest realization of the project as it increases the possibilities of marketing; but transferring money without a proven stage of marketing leads to a risk shifting to the account of the banks (Brauer, 2006). Hence, forms of financing that meet both interests have to be developed.

Acknowledgement of previous work and use of literature

1.2

2 overcome uncertainty and information asymmetry. This approach is incomplete and does not present the complete situation. Overcoming information asymmetry, reducing uncertainty and hence the risk of default is only one side of the coin.

Small firms are not only a factor of nuisance and risk for banks. Literature more and more acknowl-edges the growing importance of the SME sector. Small and medium-sized enterprises represent the majority of today’s economy. Current political developments shift the focus increasingly on SME development and start-up support in the hope to encourage job creation and secure tax income (Ough-ton & Whittam, 1997; Storey, 1994; Audetsch & Thurik, 2001). Banks and other capital providers can also no longer ignore SMEs, and there are signs that they are increasingly recognizing the potential of SMEs as customers (Stuart, 2012). Banks can generate significant revenue with SMEs. Thus, this the-sis focusses on business development rather than on risk management.

As there is absolutely no previous scientific work specially dealing with the design of the aforemen-tioned collaborative deals to enhance access to financial resources of SMEs in general and small real estate developers in specific, other relevant literature, which can act as the basis for an own study with scientific interviews, has to be used.

Relationship banking, including the size of firms and banks, effects of close relationships on credit availability and interest rate and future developments regarding bank- small business relationships, play an important part within the theoretical framework. Sufficient theory in this area is needed, since it is to be investigated whether close relationships between small project developers and banks facili-tate assessment processes for the banks by decreasing transaction costs. A positive effect is especially expected on search and information costs. Furthermore, the theory section includes literature describ-ing transaction cost economics and illustratdescrib-ing the process of real estate financdescrib-ing. It is interestdescrib-ing to combine these two areas to examine whether the specific transaction costs related to real estate trans-actions can be reduced through an integrative approach (collaboration between small real estate devel-opers and banks). Lastly literature dealing with growth strategies of banks and opportunity identifica-tion is needed, as it is one of the key issues to investigate if banks really see the previously explained collaboration deals as business opportunities and whether small firms can offer sufficient incentives, so that banks become willing to enter those deals.

Purpose of the thesis

1.3

devel-3 opers to enhance their ability to acquire financing by creating a stimulus in form of offering attractive incentives so that banks are willing to enter collaboration deals, which lead to benefits for both sides. Possible collaboration deals and the associated incentives were derived from introductory interviews with both, representatives of the banking sector, and of a small real estate project developer, the Han-segrund Bremen GmbH. The latter were willing to cooperate with me during the whole thesis project and share all information, for example regarding representative construction projects etc. The possible collaboration deals and incentives for banks and small real estate project developers to engage in those deals are presented in the table below and thoroughly described later:

Collaboration deal

Incentive for the bank Incentive for the small project developer

Number 1  Possibility to offer loans (mortgages) directly on the spot to a new group of potential customers (powerful marketing instrument)

 Reduction of transaction costs

 Access to financing

 Improved conditions of the construction loan

Number 2  Possibility to offer parts of the property of the real estate developer to clients as investment opportunities and generate commission (brokerage fee)

 Reduction of transaction costs

 Support of sales

 Access to financing

 Improved conditions of the construction loan

Number 3  Pre-emption right to purchase parts of the property of the developer

 Reduction of transaction costs

 Access to financing

 Improved conditions of the construction loan

Table 1 Collaboration deals

4 Collaboration deal number 2 comprises that banks could also offer properties of their small business partners, or parts of the properties (apartments), as investment possibilities to their private clients dur-ing usual counseldur-ing sessions. This is only interestdur-ing for banks offerdur-ing brokerage as a part of their service portfolio. By means of successfully broking parts of the property, the bank can generate reve-nue in terms of commission (brokerage fees). Moreover, there is again the possibility to achieve trans-action cost economies, since the costs of finding promotion orders (getting the request to broker) of a project can be saved and the analyses for the construction loan can be used again for additional reve-nue creation. In return, access to financing should be facilitated for the small real estate developer. Moreover, the sales activities of the project developer are supported.

In addition, collaboration deal number 3 grants the bank a pre-emption right, which establishes a prior-ity position for banks to purchase the property they were granting a construction loan for as an invest-ment object. This is only interesting for banks listing real estate as part of their investinvest-ment portfolio (Commerzbank, 2012). In this context banks can again generate transaction cost economics as they only have to analyze the property once, but can earn twice: first by granting the construction loan, and second by making use of the investment opportunity.

It is interesting to investigate if banks rate the aforementioned collaboration deals as business opportu-nities and signal readiness to deepen relationships with selected SMEs and if this can really lead to an improvement of access to external finance for SMEs.

Research questions

1.4

In line with the purpose, research questions have been outlined as the following:

1. Do banks identify incentive 1, incentive 2 and incentive 3 as business opportunities?

2. Do incentive 1, incentive 2 and incentive 3 lead to decreasing transaction costs for the banks? 3. What is the effect of relationship banking on the transaction costs of the banks?

5

2 Theoretical framework

This section is intended to present the theoretical background for my own explorative study of the aforementioned collaboration deals by means of conducting expert interviews, and act as a benchmark for the discussion of the interview findings. The theoretical framework comprises literature regarding small and medium-sized enterprises (SMEs) and real estate development, the process of financing real estate development, SME finance, the relationship between SMEs and banks and possible incentives for banks to enter collaboration deals.

Small and medium-sized enterprises and real estate development

2.1

This master thesis specifically deals with smaller enterprises in the real estate development sector and means of how to improve their access to finance; hence, a definition of SMEs and some of their char-acteristics are presented now as a starting point. This is supplemented by providing an insight to real estate project development as this sector will be used as an exemplary scene for the discussion of the thesis topic.

2.1.1 Definitions

There is not one optimal (binding) definition of smaller enterprises. Carter and Jones-Evans (2006) present two early efforts to define small firms from 1971 by the Bolton Report and one newer defini-tion from 2005 by the European Union (EU). The first definidefini-tion of Bolton is qualitative and says that a small enterprise has to be independent, managed in a personalized manner and vested with low mar-ket share. Bolton´s second definition is quantitative and considers different sectors:

Table 2 SME definition Bolton Report Source: Bolton Committee, 1971

The newer definition from 2005 by the EU subdivides smaller companies into three categories, which are assigned to different employee, turnover and asset thresholds:

Sector Definition

Manufacturing 200 employees or less Construction 25 employees or less Mining and quarrying 25 employees or less

Retailing Turnover of 50.000 Pounds or less Miscellaneous Services Turnover of 50.000 Pounds or less Motor trades Turnover of 100.000 Pounds or less Wholesale trades Turnover of 200.000 Pounds or less Road transport Five vehicles or less

6 Table 3 SME definition EU

Source: EU, 2005

The obvious problem with all of these definitions is that it is not really possible to apply a couple of measures which are fully indicative of the size of a company. In addition, the small business sector is strongly characterized by its heterogeneity (Carter & Jones-Evans, 2006). For the case of this thesis, Bolton´s second definition seems to be the most suitable, as it specifically considers the construction sector.

2.1.2 Characteristics

It is important to deal with the specific characteristics of small companies, as they have an overall influence on the accomplishment of the collaboration deals described above. The characteristics of SMEs affect the important concept of relationship banking, the possible negotiations of the deals be-tween small project developers and banks and thus the perception of the deals as business opportuni-ties.

Smaller companies usually offer a limited product or service portfolio and depend on a limited number of customers, which leads to higher uncertainties (Carter & Jones-Evans, 2006). Another peculiarity of smaller firms is their resources and the way they work with them. Obviously, resources are scarce in SMEs. Darnall, Henriques and Sadorsky (2010) observed that the limited resources are rather used to treat instantaneous environmental concerns, for example by increasing internal efficiency, external legitimacy, business value and competitive position.

Limited resources and higher uncertainty are expected to decrease the attractiveness of small firms for their banking partners. Hence, collaboration deals with them are rather not identified as business op-portunities and their bargaining position debases.

Moreover, small firms are found to have higher market responsiveness. Their less bureaucratic struc-ture simplifies decision-making processes, for instance by guaranteeing rather straight communication lines between employees and managers or owners, and can also be beneficial concerning their innova-tion capabilities (Darnall, Henriques, & Sadorsky, 2010). A similar descripinnova-tion of SMEs is presented by Brand and Bax (2001), who describe small scale, personality and independence as their core char-acteristics. Other typical features they name, like innovation or niche strategy, new customized prod-ucts, use of external networks, informal, direct communication and scarce management competencies, support the understanding of how the small business sector works.

Enterprise Category Headcount Turnover Balance Sheet

Micro smaller than 10 2m Euro 2m Euro

Small smaller than 50 10m Euro 10m Euro

7 Regarding the marketing practices of small firms, which are a highly important factor when banks grant construction loans, Coviello and Brodie (2000) confirmed the common critique that they are non-traditional, informal, short-term and non-strategic. This could be a significant disadvantage for small firms from the real estate development sector applying for construction loans as the loan needs to be paid back by the marketed real estate project.

Another important aspect is that not all SMEs are growth-oriented (Masurel & van Montfort, 2006). Nevertheless, there are of course significantly growing small firms. The growth attitudes of the man-ager, the entrepreneurial orientation of the firm and the dynamism of the firm´s task environment have the strongest influence on growth (Wiklund, Patzeld, & Shepherd, 2009). Also, the majority of SMEs are led or managed by their owners (O´Regan, Sims, & Ghobadian, 2005). O´Gorman, Bourke and Murray (2005) went further assuming that the managerial skills of these owner managers are usually low, which impedes strategic and organizational development of small companies. His study revealed, that owner managers are more integrated in the operational work of the firm, which also leads to more interpersonal contact and that their way of communication is less formal. A growth-orientated attitude of the management is highly important for banks when assessing business opportunities.

One of the very central issues and most dominant problems that small and young firms have to face is financing. A common solution for small firms is to ask their friends and family for funding. Over and above, small firms do have to face higher financing costs and consider shorter-term financing options (Gregory, Rutherford, Oswald, & Gardiner, 2005).

2.1.3 Real estate project development

Real estate project development comprises several fields of action. For illustration purposes, the pro-cedure of real estate development is described in the following.

The first phase can be called information procurement. This means that either an interesting property is already available and a suitable project idea still needs to be found, or the other way around. Fur-thermore, a location/ market analysis and an efficiency analysis need to be produced. This phase ends in the decision whether to invest or not.

Subsequently, the whole project needs to be planned. This step comprises, for example, the clarifica-tion of the financial precondiclarifica-tions, legal work (registry of deeds, separaclarifica-tion of the property, construc-tion permit etc.) and the design of contracts. Meanwhile, marketing (renting out or selling) of the property should already start.

8 A project developer can act in two different ways. First, as a service contractor, who is assigned by the owner of a property to develop the project and usually also do the construction work, or second, the developer acts as an investor himself, who develops the project at his own expenses to market it later. Obviously, in the latter option, the project developer has to carry all the risk himself.

The real estate development sector is represented by a community of rather many SMEs than only a few large players (Brauer, 2006).

The exemplary firm from the project development sector, which was questioned during an introducto-ry interview to examine the relevance of the topic and obtain some first insights, the Hansegrund men GmbH, acts as an intermediate investor and carries all the costs and risk. The Hansegrund Bre-men GmbH buys old single family houses in central locations of BreBre-men in Germany, refurbishes them and separates them into different apartments. Eventually, the individual apartments are sold to ultimate investors.

The process of financing real estate development

2.2

For real estate transactions, large sums of capital are necessary. This capital is usually raised by a lender (e.g. a bank) that lends money in exchange for future payments and an equity investor that pro-vides the remainder (e.g. a project developer, a private person etc.). Sirmans (1989:4) defines financ-ing as “the process of borrowfinanc-ing (raisfinanc-ing) or lendfinanc-ing (providfinanc-ing) funds or capital”. The two parties participating in this transaction, the borrower and the lender both have individual goals and objectives but also constraints. They make the decision to enter the financing process by comparing the costs and benefits associated with it. The common financing instrument associated with private borrowers in-vesting in real estate is a mortgage, which is a tool to pledge real estate as security and mainly com-prises rather long-term loans. Exemplary risks regarding long-term investments are:

1. Risk of inflation (lender would be paid back in “cheaper” Euros)

2. Risk of default (the possibility that the lender will not get repaid and has to foreclose the prop-erty)

3. Business risk (e.g. problems in the overall business environment like declining property val-ues)

9 Borrower makes decision to borrow Mortgage application to lender(s) Borrower analysis

Loan decision making

Approved with modifications Postorigination decisions Denied Approved Property analysis Legal environment

analysis Loan market analysis

Figure 1 The process of making real estate lending-borrowing decisions Source: Sirmans, 1989:22

Measures during the legal analysis are, for example, the examination of the property title and the veri-fication whether there are any legal claims against the property. The borrower analysis obligates the bank to check the financial situation of the borrower, the borrower’s track record and intention to pay back and the general risk of default. Another important step is the analysis of the property. This needs to be carried out since repayment of the loan is directly linked to the value of the property in some cases and also as the property serves as collateral. Thus, an appraisal is necessary. The last step before loan decision making is the market analysis to consider possible implications of external economic factors, availability of funds, inflation expectations and the current condition of the financial market. After all of these analyses a loan decision must be made, including the price of the loan (interest rate), possible restrictions (e.g. due-on sale clause or prepayment penalty) and origination fees. Sometimes a loan is only approved with modifications like a lower loan to value ratio, a private mortgage insurance, modified payment schedule, modified interest rate, or additional collateral. After granting a loan, rec-ords of payment need to be kept, overdue notices sent out and sometimes banks need to handle default and foreclose properties (Sirmans, 1989).

10 developers frequently act as an intermediate investor, which means they are only investing to sell to an ultimate investor. A construction loan is used to finance the creation of value (Brauer, 2006). Granting construction loans is associated with more risk for the lender, since the property cannot be fully used as collateral. The building measure is uncompleted and construction only by itself represents high risks (Sirmans, 1989). Thus, banks analyze applications for construction finance very critically. The specific risks are completion risk, cost risk, marketing risk, liquidity risk and the risk of wrong appli-cation of funds. The risk of completion is highly relevant as an uncompleted object cannot be utilized during foreclosure. Hence, solvency and know-how of the project developer need to meet high re-quirements of banks. The cost risk is especially a problem, if the lending limit is already reached. If the calculated investment costs are set too low, a financing gap will develop, which would have to be covered by either equity or additional funds. In addition, the decision to grant a construction loan sig-nificantly depends on the estimation of marketing chances of the property. Eventually, the loan is sup-posed to be paid back by the sales revenues from selling parts of the property or the whole one. In this context, banks particularly assess the skills of the sales department of the project developer and the building project itself. The fourth risk factor, liquidity risk, develops if outpayments are larger than inpayments in the long run. Lastly, banks have to cope with the risk of wrong application of funds if the project developer works on multiple construction projects. Loan officers are not fully able to simp-ly make sure that all the granted funds are actualsimp-ly used for the intended project (Brauer, 2006). During the assessment of the project developer, the following aspects are particularly important: de-scription of the construction project, financial blueprint, solvency documents (annual financial state-ments of the previous years, investment appraisal, proof of equity and an overview of all the so far completed construction projects), location- and market analysis, target group, time schedule, specifica-tions of a building and construction drawing, building permit and land register record. Major argu-ments for the approval of a construction loan are experience and equity. Thus small and young firms are clearly at disadvantage (Brauer, 2006).

The disbursement of a construction loan is usually made in installments spread over the term of the loan and repayment takes place as a lump sum (accumulated principal and interest) at the end of the loan term (Sirmans, 1989). Another possibility of repayment is to pay back the loan step by step de-pendent on marketing stage of the development project (Brauer, 2006).

SME finance

2.3

11 partner and are well advised to also take a thorough look at the people in charge (Timmons, Spinelli, & Zacharakis, 2005).

The acquisition of financial resources is one of the key issues for small companies, especially in the real estate development sector. This process is characterized by uncertainty, which usually leads to the need of collateral, and information asymmetry, which offers the possibility of moral hazard and thus can cause adverse selection. In this case, moral hazard means that the borrower can make use of his information benefit for instance by taking more risk than concerted. The phenomenon of adverse se-lection has the result that entrepreneurs following good opportunities are driven out of the market, because as the lender is in a disadvantaged position regarding information, he cannot differentiate between the companies following good and the companies following bad business opportunities. Thus, the lending institution will solely offer average rates (Shane, 2004). Thus, only firms following low quality business opportunities have a good reason to search for financing. The investor (bank) can face the uncertainty problem, by assessments like screening or monitoring the borrowing company and the enterprises it is undertaking, but this will of course cause higher transaction costs (Scholtens,1999). Several authors present solutions to the information asymmetry problem. Shane (2004), for instance, provides a very extensive list of alternatives. He names self-financing, which obviously abolishes in-formation asymmetry; contractual solutions, like the use of equity to decrease moral hazard; pre-investment tools as due diligence or only executing geographically localized pre-investments; post-investment tools, like ensuring control rights, and social ties between the bank and the borrower. If the loan officer of a bank knows the borrower, the chances of opportunistic behavior and information asymmetries are reduced. Besides, borrowers can also act and behave in a way which generates trust. In this context, Shane talks about sharing information instead of hiding it, acting trustworthy and using communication as a tool to influence your counterpart. Additionally, entrepreneurs who own a lot of their own company (equity) and thus signal the belief in the actions they are undertaking and are armed with features like good education, experience, high need for achievement and locus of control, have better chances to be accepted for financing (Shane, 2004).

Scholtens furthermore discusses this problem in his above mentioned article from 1999. He adds col-lateral and covenants, relationships and reputation to the list of possibilities to decrease information asymmetries between borrowers and lending institutions and claims that all of these are applicable by small firms. Collateral and covenants enhance the ex post bargaining position of the investor and thus decreases the chances of moral hazard, good relationships between borrower and lender improve the assessment possibilities for banks and hence reduce the risk and lastly reputation can signal trustwor-thiness, which again decreases uncertainty.

12 This has a negative influence on their conditions of financing (e.g. higher funding costs). Furthermore, he found out that lending institutions have significant problems to detect the risk of default associated with small business borrowers, which is especially problematic for small firms, because the infor-mation asymmetry problem between borrowers and lenders are stronger in the case of small business-es. However, he still claims that the use of internal funds, collateral and covenants, creating relation-ships between lenders and borrowers and a trustworthy reputation are possibilities applicable by small firms to decrease the information asymmetry problem and thus increase their attractivity to get fi-nance.

This has to be critically questioned. Columba et al. (2010) and Wilcox (2011) state that small compa-nies, especially when they are young, have low internal funds, less collateral, less extensive track rec-ord and their financial statements are not as transparent and informative, which complicates the as-sessment process for banks.

So, basically the only possibility left for small companies is to create relationships with their banking partners.

The relationship between SMEs and banks

2.4

Relationship lending, which is a topic of increasing interest for both, academic research and banks, describes a fixed relationship between a firm and its house bank that goes beyond simple and anony-mous financial transactions. The period of interaction is long-term (Elyasiani & Goldberg, 2004). Scientific literature exclusively talks about gathering (confidential) information about creditworthi-ness, and thus overcoming the information asymmetry problem to some extent in order to decrease uncertainty and risk, as the reason why to engage in relationship banking for financial institutions. As already described, this thesis takes a slightly different approach, which has not been presented so far in scientific literature. It attempts to investigate whether relationship banking has a positive influ-ence on the assessment costs of banks (in particular on search and information costs) and thus can be made use of by SMEs from the real estate construction sector to improve access to external finance as a part of the collaboration deals.

13

2.4.1 Features of relationship banking and its effects

Usually banks have very clear requirement profiles for their borrowers. They rather prefer to lend to established businesses with extensive track record of sales, satisfied customers, credit history and prof-it. To minimize the risk associated with a borrower, they first look at positive cash flow and second at collateral like stocks, machinery, equipment and real estate. Another important issue, especially for long-term investors, is the quality of the management team. As previously explained, small and young firms are significantly disadvantaged in this context. Another negative point is, that in today’s banking market, which is increasingly consolidating decision-making is more and more centralized. Decisions to grant a loan are frequently made by loan committees or credit scoring. Hence, it is much difficult to establish close relationships to banks and their loan officers. On the other hand, this is exactly what managers of small businesses depend on. They rely on their salesmanship and good relationships with their house banks. In depth financial analyses and documentation are usually not available to the same extent as they are in large companies. Cultivating a close relationship with their bank is important for small firms. This requires that small firm managers have to be much more active in keeping banks informed, in order to improve access to larger loans and other forms of cooperation with banks. To create such relationships, the small firm managers could, for example, send in updates about current projects, draw up monthly and annual financial statements, invite the bankers to the company’s facili-ties and establish a personal relationship. Furthermore, small companies could also start borrowing when they are not desperately in need of money and then repay the loan after a while to establish a track record of reliable payment (Timmons, Spinelli, & Zacharakis, 2005).

Elyasiani and Goldberg (2004) found that the average length of a relationship between SMEs and the banks where they applied to for a loan is 7.8 years. Furthermore, they discuss the effects of relation-ship banking on several important features of financing. The most important aspect for small business-es is above all fund availability and quantity. In this rbusiness-espect Elyasiani and Goldberg (2004) found that firms that already have long and strong preexisting relationships with banks have greater availability of funds and also lower costs of funding. Additionally, Boot and Thakor (1994) claim that longer and mature relationships lead to declining interest rates and collateral requirements. This positive effect of relationship lending on SME credit availability is confirmed by Petersen and Rajan (1994).

fi-14 nancing due to the hold-up problem, which means that banks make use of dependencies and their mo-nopoly power over the firm.

2.4.2 Relationships and the size of banks and firms

There is a widespread assumption in the relevant academic literature that only small banks are inter-ested in the SME sector in general and in relationship banking in specific (Elyasiani & Goldberg, 2004). There are several reasons reinforcing this presumption. The mere size of many large banks makes it almost impossible for small firms to have some influence. This can quickly lead to frustra-tion. Moran (2010) claims, that small firms partnering up with small and local banks are rather satis-fied with their business relationships. Some of the reasons for this, next to the possibility of having some influence, are that smaller banks are simply more committed to attracting small business cus-tomers, retaining them and cooperating with them in a communicative manner. He furthermore em-phasizes how important it is for a small firm to strategically choose a banking partner. This requires extensive research and it is highly important that the responsible people within the bank have industry knowledge.

Relationship banking is based on soft information (non-quantifiable), whereas all the other lending technologies are rather based on hard (quantifiable) information (Udell, 2008). It is difficult to influ-ence the decision making process in large banks as lending officers and owners, or central decision makers, are usually not the same person. Lending officers usually have incentives to grant more loans as they are paid commission, which might be in conflict with the wellbeing of the bank and its owners. Because of these agency problems, large banks need to establish standardized loan approval processes based on quantifiable data (Elyasiani & Goldberg, 2004).

15 survey showed that this market has already become competitive, but not saturated and still has huge potential for the future. Moreover, small banks do not necessarily have an advantage to serve SMEs. Due to their service platforms, different branches, technical expertise, risk management systems, IT and back-office infrastructure, large banks can make use of economies of scale and scope providing a large number of small firms with all kinds of products and services. Granting loans is just a small part of what can be offered and the business with SMEs becomes really profitable through cross-selling. Lending is often just used as an introduction to a long-term relationship between a bank and a small firm. Other highly profitable fee-based services especially for SMEs, like payment transactions, sav-ings and advisory mandates, have already been developed by the banks. Many banks expressed the overall target to become the principal bank, the house bank, of SMEs and to bind them to an all-embracing relationship, which in the long-run might also facilitate an increasing amount of lending to each SME. Overall, the study of De la Torre, Martinez and Schmukler (2010) found that banks are already significantly involved with SMEs, see them as important customers and still have a growing interest in this sector. Most of the banks participating in the survey already have separate, especially dedicated small business units. The usual products offered to SMEs are first of all deposit or saving products like checking or savings accounts and investment, secondly financing products like loans, credit cards, factoring, leasing and international trade financing and thirdly services and other products like foreign exchange, international payments and collection, payment to employees, payment to sup-pliers, tax payments, collection of receivables and insurance products.

2.4.3 Tendencies and possible future developments regarding bank - small business relation-ships

Timmons, Spinelli and Zacharakis (2005) describe the situation in 2003, when interest rates reached historical lows. As a result, availability of bank loans was much higher. The competition between banks drastically increased. The credit loan environment was friendly and access to credit was easy. This atmosphere led to the fact that banks were aggressively increasing their marketing efforts to spe-cifically target small firms with the intention and potential for growth. The actual situation today shows many similarities. Besides the worldwide financial crisis, the economic world in the western society is changing. The importance of the SME sector and entrepreneurship is growing (Audretsch & Thurik, 2001; Oughton & Whittam, 1997; Storey, 1994). Thus, banks are taking note of this develop-ment and an intensification of their efforts regarding their relationships to the small business sector can be expected.

16 banking were hired. Currently, there are many government programs supporting small business financ-ing and the refinancfinanc-ing possibilities of banks are extremely cheap. Nevertheless, these measures do not really lead to an overall satisfactory situation regarding small business finance. Access to loans still remains one of the biggest difficulties for small and young firms. It is not the cost of capital that is constraining, but the inability to predict where the economy is going. Building relationships is still an important factor to improve access to financing for small firms. Thereby a history of meeting and ex-ceeding goals and a personal relationship to the loan officer can be created.

Possible incentives for banks to enter collaboration deals

2.5

To improve access to construction loans, or to external finance in general, small firms are not forced to act passively by means of simply accepting that they represent higher risk for banks. They can try to establish close relationships leading to partnership and collaborative deals, but to do so, they need to offer banks attractive business opportunities, incentives.

First, the following sub-section imparts an impression how banks are actually earning money. Follow-ing that, growth strategies of banks are presented, then the important topic of opportunity identifica-tion is further illustrated and finally the theoretical concept of transacidentifica-tion cost economics is described.

2.5.1 How are banks earning money?

Taken as a whole, banks offer a wide range of products and services today. Beside the traditional core banking services such as lending, payments, treasury etc., banks have lately been more and more in-volved in the investment banking sector. Additionally, advisory services, for example regarding mer-gers and acquisition, and brokering insurances and real estate are common services offered (Com-merzbank, 2011).

Regarding loans, banks seek out for return consisting of four different elements. First, there is the real

return, which is a compensation for deferred consumption. The second part is called inflation premi-um. This is a compensation for the possible declining value of a currency. Thirdly, banks hedge their

assets by determination of an inflation risk premium that is supposed to compensate for the possibil-ity that the inflation premium was underestimated. This is done as it is highly difficult to forecast in-flation accurately. The last part is the default risk premium. This is a compensation for the possibility that the loan will not be paid back as agreed. A positive credit history, collateral and a close relation-ship with the bank will decrease this premium for the borrower (Sirmans, 1989).

2.5.2 Growth strategies of banks

17 comes to the conclusion that growth through the acquisition of other banks is the most effective way to grow.

In his paper, Jackson (2007) presents compelling reasons why banks must re-formulate their strategies for growth and profitability. He argues in support of strategies focusing on individual customers. De-regulation has led to more competition from non-banking institutions and hence the banking industry has to deal with significant losses of financial assets held by private customers and stagnant growth of demand of their products and services. Expansion of products and markets could be a solution to in-crease earnings by both, generating new customers and deepening relationships with existing custom-ers.

This change in the banking world is confirmed by the recent study of Carande and Anzevino (2010). They claim that the banking sector has to face a new time and economic reality. Banks urgently need to find new sources of revenue growth. They name a recent KPMG survey, which shows that after the economic crisis, banking executives see the development of new strategic business models as the most important challenge. The two possible strategic business models that banks could adapt in the future are “back to basic” and “innovative”. “Back to basic” suggests that banks should rather focus on pri-vate and commercial clients, offering checking and savings accounts, mortgages etc. in a combination with superior service, and reduce efforts regarding investment banking. The “innovative approach”, on the other hand, seeks to add value by offering truly new products and services and thus raise additional fees. An already realized innovative measure can be associated to branch customer service. Some banks are actively trying to improve their customer service. This leads to higher customer satisfaction, which intends to push cross-selling of additional services and offerings.

18 Teng (2003) adds another interesting point. He is more specific when writing about alliances and no-ticed increasing value in alliances with complementors. These collaborations make the firm´s products or services more attractive and accessible and may generate new businesses for a firm. Cooperation with complementors can help to explore emerging market segments, but most importantly is another associated way of increasing sales which is product or service bundling. An appropriate example would be a computer manufacturer collaborating with a printer manufacturer and then selling both products together. Such alliances do have significant effects on costs, economies of scope, efficiency from accomplishing related activities together and sometimes also reputation of the firms.

2.5.3 Opportunity identification

After all of this theory, the question still remains whether banks really see collaborative deals as an opportunity.

Wickham (2006) describes an opportunity as a gap in the market, where the potential is there to do something better and thus create value. He realized that business opportunities can come in several ways. Two of these are new ways of managing relationships and new operating practices. The first is an innovation of the way how firms work with each other and the latter describes the routines of operating practices behind the delivery of services, which offer high potential for entrepreneurial in-novation. Wickham says that firms have been especially active regarding new ways of managing rela-tionships during recent years.

Shane and Venkataraman (2000) state, that not everybody is able to identify business opportunities. The value of an opportunity is not obvious. The possession of information to identify an opportunity and the cognitive properties to value it are important prerequisites to successfully identify opportuni-ties. Furthermore, the decision to finally exploit an opportunity is supported by a large number of fac-tors. A list of these factors is presented below (Shane & Venkataraman, 2000):

1. Expected value of opportunity profit is large enough to compensate for the opportunity costs 2. Expected demand is large

3. Industry margins are high 4. Young technology life cycle

5. Neither too low or too high density of competition 6. Available learnings from other entrants

7. Large amounts of capital are accessible 8. High previous knowledge

9. Over-optimism and different perceptions of risk 10. High tolerance for ambiguity

19 Ardichvili, Cardozo and Ray (2003), who developed a theory of entrepreneurial opportunity identifica-tion and development, see the recogniidentifica-tion of opportunities as a process comprising percepidentifica-tion, discov-ery and creation. People are not equally talented regarding their sensitivity to market needs or prob-lems. Factors that influence the identification of opportunities are entrepreneurial alertness, infor-mation asymmetry and prior knowledge, social networks, personality traits and the type of opportuni-ty. A high level of alertness leads to a high likelihood of opportunity recognition. Prior knowledge and the allocation of information have a significant impact since people tend to notice opportunities related to their previous knowledge. Social networks automatically lead to information exchange and thus to a higher probability of discoveries. The most important personality traits influencing opportunity recog-nition are optimism and creativity. Finally, the type of opportunity has a huge influence. Ardichvili et al. present the following systematization:

Figure 2 Opportunity systematization Source: Ardichvili, Cardozo, & Ray, 2003

The process of opportunity development could differ among these four types of opportunities, which are namely dreams, technology transfer, problem solving and business formation.

Nicolaou, Shane, Cherkas and Spector (2009) add a genetic perspective. They follow the assumption that opportunity recognition is heritable. Genes have a significant effect on people´s openness and their tendency and skill to form social networks.

20 1. How large is the

oppor-tunity?

 What is the total value of sales?

 What share of the market is likely to be gained?

 What percentage of customers can be reached?

 What gross margin (revenue minus costs) is likely? 2. What kinds of

invest-ments are necessary to exploit the opportunity?

 What are the immediate capital requirements (people, operating assets etc.)?

 What are the ongoing capital requirements?

 Does the business have access to the required capital?

 What human resources are needed and are they available? 3. What is the likely

re-turn?

 What profits over what period will be achieved?

 Is this attractive given the investment necessary?

4. What are the risks?  How accurate was the data to make assumptions about profits etc.?

 What if customers do not find the offering as attractive as ex-pected?

 To what extent is the success dependent on the support and goodwill of third parties?

 How expensive are possible adjustments?

 What will be the effect on cash flow if revenues are lower than expected or if costs are higher than expected?

Table 4 Opportunity valuation Source: Wickham, 2006

2.5.4 Transaction cost economics

Decreasing transaction costs could be an incentive for banks to enter collaboration deals with small firms from the real estate construction sector.

21 Asset specificity describes the problem of assets that are especially designed for a particular transac-tion and cannot easily be re-deployed outside of the dedicated relatransac-tionship. Thus, a so called safe-guarding problem can develop, since transaction theory assumes the possibility of opportunistic be-havior. There is a risk of exploitation of dependencies. Uncertainty, the second dimension of transac-tion, describes environmental uncertainty (environment is too unpredictable to be specified in advance in contracts) and behavioral uncertainty (performance of transaction partner cannot easily be measured retrospectively). Finally, transaction frequency also leads to vertical integration, as frequent transac-tions simplify recovering of overhead costs of hierarchical firm governance (Williamson, 1975, 1985). According to Coase (1988), firm and market together build the institutional structure of the economic system. There is a cost of using the market (e.g. identify relevant prices). Contracts are a possibil-ity to exchange transactions. Transaction costs help to understand why firms exist. They comprise search and information costs, bargaining and decision costs and policing and enforcement costs. Wil-liamson (1985) furthermore suggests distinguishing ex ante and ex post transaction costs. Ex post transaction costs are related to agency costs: monitoring expenditures of the principal, bonding expenditures of the agent, and the residual loss. Markets are institutions that exist to facilitate ex-change, reduce transaction costs and thus increase the volume of trade and economic value crea-tion (Coase, 1988).

Jacobides (2005) examined the US mortgage banking industry and recognized significant vertical disintegration. He analyzed the industry from the 1970s, when mortgages were still originated, funded and serviced by an integrated banking institution, until the late 1990s when the industry completely changed to a collection of specialized firms working together.

Jacobides (2005) discusses the “production” of a loan, which involves the following steps: (1) lenders with excess funds need to be identified; (2) borrowers looking for a loan are found and linked to the lenders; (3) the borrower’s creditworthiness is checked, including collateral etc. and paperwork has to be done (insure titles, deeds, legal requirements); (4) closure of the loan; (5) servicing of the loan; (6) payments to the lender. A disintegrated process involving several spe-cialists could look as follows. Firstly a mortgage broker links to mortgage banks. Mortgage bro-kers basically prepare mortgage loans and seek, qualify and educate clients. Finally they sell the mortgage loan application to mortgage banks. Secondly, these banks grant the loans, and thirdly they “store” the loans until they can sell it to securitizers. One can sometimes even distinguish between mortgage banks focusing on servicing, and other banks rather dealing with originating loans.

22 showed that their willingness to change the boundaries of their institution was triggered by the possibility to increase margins, be more effective, or gain market shares (Jacobides, 2005).

23

Research model

2.6

Figure 3 Research model

This thesis is about improving access to construction loans for small real estate developers. This is supposed to happen by means of negotiating collaboration deals, which are of mutual benefit. Small firms from the real estate industry can offer banks a powerful marketing instrument, brokerage fees and pre-emption rights to invest in developed properties as incentives to enter the collaboration deals. In a first step it is investigated whether the banks really identify these incentives as business opportu-nities. A positive result is expected, since a collaborative approach is intended to decrease transaction costs (especially assessment costs) of the banks. Furthermore, the concept of relationship banking is included in the conceptual model. Relationship banking also has a positive effect on the transaction costs of banks (in particular on search and information costs) and plays a major role in the relevant literature as a tool to enhance access to finance for SMEs.

24

3 Methodology

To answer the research questions a case study based on extensive theoretical research was conducted. Primary (empirical research) and secondary (desk research) qualitative data was used.

Primary data was gathered by carrying out two rounds of expert interviews with bank representatives. The interviewed bankers are all active in leading executive positions and represent banks with differ-ent thematic oridiffer-entations. Due to the rules of compliance of the banking institutions, I had to anony-mize the names of the banks and respondents. A table with all the respondents, their function and or-ganization, and the type of survey carried out can be found below:

Respondent Bank Function Type of survey

Interviewee A Bank A Director Corporate

Clients Real Estate

Questionnaire 1

Interviewee B Bank A Director Corporate

Wealth Management

Questionnaire 1

Interviewee C Bank A Relationship Manager

Corporate Clients

Questionnaire 1 and 2

Interviewee D Bank B Director Structural

Finance Real Estate

Questionnaire 1

Interviewee E Bank C Director Private

Bank-ing

Questionnaire 1

Table 5 Respondents

The first round consisted of four different interviews with representatives of three different banks. After the first round, a second interview with Interviewee C from Bank A seemed to be necessary to broach the important subject of transaction costs again. It was extremely difficult to obtain insights in transaction costs. One of the reasons for this is most likely that banks are rather closed institutions that do not like to share the specific costs of transactions. The other reason was that the respondents simply did not now the transaction costs. Thus, I had to develop a proxy to get these insights. A second, more directive, questionnaire had to be developed, which asks for the Bank A´s time exposure needed to execute all the processes related to granting construction loans and mortgages that could cause transac-tion costs on the basis of two exemplary representative constructransac-tion projects of the Hansegrund Bre-men GmbH. One relatively small and one relatively large project were chosen.

25 the undisputed market leader in the Bremen region and the house bank of the Hansegrund Bremen GmbH. Especially the partnership with the Hansegrund Bremen GmbH enhanced Bank A´s willing-ness to share information. There are no more questions regarding incentive 2 and incentive 3 in the second questionnaire, as the results of the first questionnaire already showed that the banks do not identify them as business opportunities.

The first round of interviews collects information regarding relationship banking, opportunity identifi-cation, transaction costs and real estate financing. The second round, as just described, focusses on transaction costs.

An interview guide, consisting of instructions for the interviews and two extensive questionnaires, was developed and can be found in appendix A. The questions for the interviews are derived from the theo-retical framework section. Additionally, secondary data were gathered by theotheo-retical research within the fields of small business management, small business finance, entrepreneurship, relationship bank-ing, real estate management, real estate finance, transaction cost economics and strategic banking. In doing so, scientific textbooks and journals were studied. Electronic databases like Business Source Premier seemed to be appropriate media to search for scientific articles and books.

Concept Primary data (interview

ques-tions)

Secondary data (theory)

Relationship banking 3 - 8 Page 12-16 + 33-35

Opportunity identification 9 - 17 Page 16-20 + 26-28

Transaction costs 18 – 23 + second questionnaire Page 20-22 + 28-33

Real estate financing 24 - 33 Page 8-10 + 36-37

Table 6 Data gathering

Furthermore, the outcomes of the interviews were analyzed by comparing them with the abovemen-tioned literature.

In order to fully understand the topic, a further-reaching empirical study would have been better than a case study to generate a wider and more representative database for the conclusions. However, the scope and timeframe of this thesis prohibits more intensive research.

26

4 Findings and discussion

In this chapter, the findings from the expert interviews are presented and discussed in light of the theo-retical framework.

Do banks identify incentive 1, incentive 2 and incentive 3 as business

oppor-4.1

tunities?

The theoretical framework shows that not everybody is able to identify business opportunities. Im-portant factors influencing the recognition of opportunities like new ways of managing relationships as an innovation of the way how firms work with each other are prior knowledge, alertness, optimism and creativity. So, how distinct are these features in the case of the interviewed experts? Three out of five of the questioned bankers consider themselves to be experts in real estate. Their level of prior knowledge in the context of real estate is high. Three of the banking experts are always interested in new business ideas and looking out for new ways of revenue creation. The other two were sometimes and occasionally interested. Interviewee A and Interviewee B claim that the lines of communication are short at Bank A, and that every idea is checked and discussed. Interviewee C confirms this. He always canvasses for new innovative business clients and discusses every idea with superior managers during regular meetings. Thus, the questioned executives can be characterized as alert. At the same time, there is a huge tendency of risk avoidance in the banking sector. All the respondents would al-ways decide for rather safe and less rewarding investment options, which is in accordance with the guidelines of their banking employers. Their level of optimism can be judged as low. Lastly, the im-portant factor of creativity is not very pronounced. Only one of the respondents can be judged as crea-tive (using question 17 of the first questionnaire as an indicator). So, in summary, the questioned bankers are not really endowed with the ability of opportunity identification. They are simply lacking creativity and optimism.

27 approximately 30 %. About a quarter of Bank B´s clients are SMEs, which is not a very high number assuming that the real estate development sector is characterized by a structure of rather many SMEs than a few large players according to Brauer (2006). At the same time, Interviewee E of Bank C states, most of their business real estate clients are definitely SMEs and Interviewee C undermines this by explaining that Bank A´s corporate clients division, which is further divided into thirteen subdivisions, has five subdivisions only supervising SMEs. These five subdivisions comprise up to 200 clients and the remaining eight corporate subdivisions for larger firms sometimes only deal with one single exclu-sive client. The respondents of Bank A and Bank B agree that the number of their SME clients has not significantly changed during the last four years. Even the players remained the same. To conclude, real estate related products play a significant role within the product and service portfolio of banks, and SMEs are important clients.

Furthermore, it is essential to investigate whether incentive 1, incentive 2 and incentive 3 fit the prod-uct and service portfolio of the questioned banks (question 9-11 of the first questionnaire). The inter-views showed that none of the questioned banks is investing in real estate themselves. Thus, incentive 3 can already be excluded from the possible business opportunities. Bank A for example tried that in the past, but made bad experiences. Interviewee A reported that they simply do not have the compe-tencies. Their field of action is finance and not construction. In addition, the Bank A does not want to act as a competitor to their clients from the real estate project development sector. An investment to just own property without further developing it is not lucrative enough according to Interviewee D from Bank B, which offers financing for project development (construction loans), mortgages and refinancing of properties. They do not broker. Bank A and Bank C on the other hand both have a sepa-rate entity offering brokerage services and also real estate management. Moreover, both banks offer construction loans and mortgages. To summarize, all of the interviewed banks are interested in con-struction loans and mortgages, whereas brokering real estate and real estate management are only of-fered by separate specialized entities of the Bank A and Bank B and none of the banks is interested in pre-emption rights to purchase properties as investment objects.

Overall, the interviews clearly revealed that incentive 1 is the only one, which was identified as a business opportunity by the banks. All of the respondents claimed that incentive 1 is by far the most rewarding and interesting option.

28 the period over which the potential profits could be achieved is usually 10-20 years. The level of risk is ambiguous. Construction loans are risky, but mortgages, especially in the segment of rather expen-sive apartments, are very safe.

So, the main reason why incentive 1 was identified as a business opportunity is because of the oppor-tunity to reach further mortgage customers. A mortgage customer usually stays with the bank at least for 10-20 years. Maybe even beyond the term of the mortgage, as the banks try to further exploit the opportunity by making use of cross-selling, which means offering the new mortgage clients additional products and services like checking accounts, passbooks etc. Interviewee C and Interviewee E even suggest that the mortgage customers are actually more interesting for the banks than granting construc-tion loans to project developers, because mortgages are by far less risky. Interviewee A even states that some sorts of collaboration deals, including incentive 1, are already frequently executed. On the contrary, Interviewee D says that this is absolutely not common practice so far.

Even the two banks offering brokerage as a part of their service portfolio do not identify incentive 2 as a business opportunity. The basic reason why, is that both Bank A and Bank C created separate enti-ties brokering real estate. Communication and collaboration is not really well between the two entienti-ties according to Interviewee C. He further said that he personally does not appreciate the work of their brokerage entity. Hence, he would rather recommend external, more professional brokers, so that the risk of marketing decreases for the real estate project he granted construction financing for.

Do incentive 1, incentive 2 and incentive 3 lead to decreasing transaction

4.2

costs for the banks?

Two rounds of interviews had to be conducted to develop an idea of the transaction costs of granting construction loans and mortgages (incentive 1) and how they are influenced by a collaborative ap-proach (cooperation between the small real estate project developer and their house bank) as opposed to two separated transactions. The transaction costs of brokerage (incentive 2) and of purchasing real estate as an investment (incentive 3) were not determined during the second round, since the ques-tioned bankers made very clear that they are not interested in these possible incentives.

29 property, Bank A has a specified department of certified property valuators exclusively assessing properties. The project calculation analysis, which only has to be done in the case of a construction loan application, comprises an assessment of the estimated costs of construction, calculations of the expected selling prices and a marketing plan. Furthermore, loan decision-making and setting up con-tracts also causes transaction costs during the process of granting loans. Especially decision-making can turn out very expensive. If the amount of required credits for a real estate project exceeds two million Euro, all analyzes have to be reviewed by employees of a higher management level, who pre-sent their results to the board of directors of Bank A. Finally, the board of directors thoroughly dis-cusses the whole project and makes the decision to approve the loan, approve it with modifications, or deny the loan. This process is obviously time-consuming; and employees of high management levels and members of the board of directors have high hourly wages. Setting up contracts is also done inter-nally. Bank A has its own legal department.

Interviewee D, the Director Structural Finance Real Estate of Bank B, claims that in addition a legal environment analysis, a market analysis, a separate risk analysis and an in-depth analysis of the struc-tures of the project development firm (partnership agreements etc.) are necessary. The latter solely concerns construction loan applications.

30

The two construction projects Project: Hermann-Böse-Straße Project: Weserstraße

Purchase price 330.000 Euro 1.320.000 Euro

Costs of construction 600.000 Euro 1.200.000 Euro

Equity 120.000 Euro 300.000 Euro

Financing 810.000 Euro 2.220.000 Euro

Number of apartments 3 7

Table 7 The two exemplary construction projects