What Is PF (Project Financing) Investment?

Financial companies offer various lending methods to increase their profits, and one of them is project financing (PF), which uses technology or business ideas as collateral.
In Korea, PF projects mainly refer to real estate projects, because real estate projects show stable cash flows.
For other businesses, financial companies' approval conditions are strict, so loans are often difficult to obtain.
# Components of a real estate PF loan
① Developer: Establishes a special purpose company (SPC), a paper company, carries out the PF project, and dissolves it when the project ends.
② Contractor: The company that constructs the building
③ Financial company: The company that extends the PF loan; it manages risk after signing a payment guarantee agreement with the contractor

# Steps of a PF project.
① Loan (bridge loan) from a savings bank or securities firm ⇒ ②The developer buys land, constructs the building and sells the units ⇒ ③After the units are sold, the developer repays the PF loan and the project ends
PF loans from ordinary commercial banks are only available once a building permit is issued, so to buy the land the developer first borrows from a savings bank or securities firm. If the project goes as planned, the land is bought and the building permit is issued, the developer takes out a PF loan from a bank and repays the high-interest bridge loan.
If it ends normally, the developer gains a leverage effect of nearly 10 times with little capital and takes a large profit.
However, because PF projects involve large loans and are mostly financed with debt, interest burdens rise when real estate prices fall, increasing risk.

#Risks in carrying out a PF project
1. If sales fall short of the target ratio, the developer (project operator) or contractor must cover the PF loan interest, so the company's financial condition deteriorates.
If the downturn is prolonged, it ultimately leads to a serious situation in which not only the developer but also the contractor and even the financial institutions that cannot be repaid collapse.
2. The initial capital required of the project operator is generally less than 10% of the total project funds.
That means more than 90% is borrowed, which means the project proceeds by paying off loans with more loans until profits are generated.
This makes it a business carried out with the huge risk that construction can be halted immediately if the flow of money is interrupted even slightly. Accordingly, for the stability of projects, the initial capital ratio needs to be raised above the current level.

In the case of the United States, it is common to raise money from investors when buying land and use it to repay the bridge loan. These conditions have become stricter especially since the financial crisis.
If part of the project funds is repaid with invested capital rather than loans, cash flow improves and the project proceeds relatively safely.
PF projects have been widely used in real estate development because they offer the prospect of large profits with little capital.
However, because of these risks, when investing in projects carried out with PF loans, you should thoroughly check the business report and proceed with caution.