Oak Laurel | Finance brokers
Property developers, do you want to talk to a finance professional about getting your finance approved? We can help.
Financing your property development project: How to get your funding approved
Property development can be financially rewarding if done right. However there are many potential pitfalls that need to be avoided in order to make your project a success.
Finance is not the most sexy part of property development but it is arguably one of the most important factors. Running out of funds before your project is completed (and sold) can be a disaster for the project. Securing enough funding but at a higher cost can erode your profit margin and turn a profitable project into a marginal one or worse.
Property development loans for large projects
Before commencing any development project you need to know how much funds you will have available to complete the project and the cost required to complete the project. If part of the funds are from finance you need to know how much you are able to borrow from a bank or other lender.
Though the concept of borrowing power is familiar to most people who have borrowed to purchase real estate, the way that banks and lenders assess property development finance borrowing power is different from that of a residential property or commercial property purchase when the property is not being developed.
As a property developer it helps to understand what the banks look for when lending for property development projects.
When deciding whether to finance your project, banks and lenders will ensure that the risk of them losing money on the project is minimal. Banks and lenders will assess the risk, firstly of you as an individual and your ability to repay the loan, and then on the viability of the development itself.
When assessing the project, Banks don’t just consider the security of the project; they also consider the experience of the developer and the development’s team. The bank or lender will want to see that the development team has a track record of successful property developments of a similar size and complexity to the one that they are asking to finance.
Therefore it is important to submit a professional, well thought out and detailed feasibility study. The lender will judge your application on the quality of your finance application.
Property development finance for large projects is different from smaller projects.
Large property development project finance (such as a multi-dwelling residential development, multi-story commercial office development etc…) is considered as commercial finance. Commercial finance including for property development, is usually charged at high interest rates than typical home loan or investment property mortgage interest rates.
Usually property development loans for larger projects can be obtained to a maximum of 70 – 80 % of the final cost of the project (often referred to as the land development cost – LDC) with the rest of the funds provided by you the developer or your equity partners.
Some lenders will allow you to borrow on a percentage of the Gross Realisable Value – GRV. Gross Realisable Value is the value of the completed project (excluding GST). However, when borrowing based on the Gross Realisable Value lenders will usually only provide up to a maximum of 65 – 75 % of the final expected value of the development (65 – 75 % of the GRV).
Larger property development projects may require a greater percentage contribution of equity or a level of pre-sales.
- the deposit;
- base stage;
- frame stage;
- lock up stage; and
- fixing stage;
the balance of development funds are supplied at the completion of the project.
Property development finance differs from ordinary investment finance as usually you can capitalise the interest (borrow the ongoing interest as part of your finance package and pay it back with the capital borrowed at the end of the loan period). This means that the interest is added to the amount you owe at the end of each month and the next month you pay interest on the interest.
If the property developer intends to keep some of their finished properties from the project, they could pay out the development loan by refinancing the property to a long term investment loan. If there is enough profit in the development project the developer may be able to keep some properties without finance with the profit from selling some of the other properties in the development.
- the finance to cover the acquisition costs of land, development application and pre-construction costs;
- the construction loan to cover the building costs of the project; and
- an investment property loan if you are retaining part or all of your project as a long term investment.
Development finance applications need to be very detailed to convince the lender that you know what you are doing and that the project will be a success. The application should start with an executive summary that quickly highlights the key points of the project including the viability and profitability of the development.
Then each of following aspects of the development project should be described in detail in your application:
- type of development (residential vs commercial)
- site description including its zoning
- a design concept
- cost of the land
- cost of construction
- cost of marketing and selling agents fees
- other costs (including the projected development financing costs; stamp duty, professional and legal fees, architect, engineering, quantity surveyor, contingency allowance, etc..)
- projected sales figures
- the profit margin on the development (including accounting for GST),
- the potential gross realisation of the development,
- the suitability for the location and the saleability of the finished property(s)
- timelines until completion
- financial strength of the property developer
- how much equity you bring to the development project
- the development experience (track record) of the developer and the developers team (project manager, architect, lawyer, accountant, builder) in relation to the size and complexity of the project.
If there are any potential serious issues then the application should demonstrate how they will be overcome.
Planning out and documenting your development in detail will not only assist you to obtain development finance, it will also assist you in organising and evaluating your proposed project so you identify problems early can make adjustments as necessary.
Therefore, second tier lenders, private funders, mezzanine finance and joint venture funders are increasingly a popular source of property development funding.
Though there are still some options for foreign property developers undertaking a project in Australia the number of options has been reduced from a few years ago.
Furthermore, if you are undertaking a large project, you may need to split your finance across more than one lender. In this case our specialist finance brokers can be of great benefit in structuring your finance.
These can include:
A fixed price building contract (also known as a fixed price tender)
This is where the cost of each stage of the construction is agreed in advance and you know exactly what the cost will be to complete the project.
Detailed construction costings
The detailed construction costings can be from your builder or a quantity surveyor’s report
Evidence of pre-sales
The evidence of pre-sales will need to be in the form of deposits held in trust. Deposits generally need to cash to the value of 10 per cent of the purchase price.
Progress payment claims made by the builder
These will be required before the lender releases the funds for the payment of the builder. Payments are usually tied to the completion of a stage in the development construction. The lender may also conduct their own inspection (via a valuer) of the development to assess the level of progress. Sometimes the lender will even require evidence that the builder has paid all of their suppliers and tradies/subcontractors so that no claims will be made against the lender in the future.
Reports from your project manager
The lender may request progress certificates from the project manager or a quantity surveyor in comparison to against projected timelines and milestones.
Cash flows and revised financial projections
An accounting of the cash flows and any revised financial projections (as a result of changes in the development costs or estimated financial sale prices, that may be due to moves in the market prices of property).
Significant delays or variations to the project and feasibility
Weather and other factors can sometimes delay a development project. These and other variations can change the timeline, cost (including interest payable) and ultimate profitability of the project. The lender will sometimes request revise project projections.
Sales that may have occurred
Developers will usually continue to market the development during the construction phase. The lender will often want to be kept up to date on the amount of pre-sales that have occurred.
Their primary considerations in doing do so are:
The price that they would get if they had to take possession as mortgagee and sell the development.
The type of development. Residential properties are considered as the easiest to sell. Rural properties, holiday resorts or serviced apartments are considered as higher risk and developments for these types of properties may require you to input a greater level of capital (have a lower LVR).
The end value of the property that you are constructing. If the properties that you are constructing are required to to be sold at a higher price than that of medium value of the properties in the area, they will be considered at potentially difficult to sell.
When assessing the feasibility of any potential development project, it is important to keep the lender’s criteria and expectations in mind. After all, a development can look wonderful on paper, but unless it ticks all of the right boxes with the banks, it will never even get off the ground. This is where a specialist property development finance broker from Oak Laurel can assist you with your finance application.
Property development loans for small projects
For example construction of a single dwelling or two dwelling on a block of land is considered as a small development project.
Some lenders also consider the construction of three dwellings as also a small development.
One lender is now considering 4 unit developments on a single title as able to be done as a construction loan up to 80% LVR at normal home loan rates. Some other conditions need to be met.
Small property development projects can often be financed as a construction loan at typical home loan or residential investment property mortgage interest rates.
Many lenders consider a 2 or 3 residential unit or townhouse development projects as construction loans and use less stringent lending criteria for this type of project.
Typically, you will need to provide 20 per cent of the funds for a 2-3 dwelling project. Some lenders consider even a 3 dwelling project as a larger project, in which case it will be classed as commercial loan and require a larger deposit (30% of the LVR) and may incur higher interest rates.