In the fifth instalment of his series on property development Bryce Yardney, property development Specialist at Metropole Properties explains in detail how to secure funding for your real estate development project.
Before you commence any development project, it is obviously crucial to first establish how much you can borrow and how you will be able to manage all associated costs of 
the development.
As a property developer you will have to understand finance and what the banks look for when lending for development projects, which is very different to how they assess financing a simple buy and hold investment.
Today lenders are allergic to risk and look after their own safety first so before deciding whether to finance your project they will assess the risk, firstly with regard to you as an individual and your ability to repay the loan, and then on the viability of the development itself.
In other words, banks don’t simply lend based on the security of the project; they also want to establish the track record of the people behind the development.
Until you develop a good reputation with the bank and a sound track record in property development, lenders will also assess your development team as well as the professionalism of your finance presentation to them.
This means it’s important to submit your loan request in a professional manner, including a detailed feasibility study to show that you have allowed for all contingencies.
Generally your development loan will be structured so the lender provides up to 70 to 80 per cent of the final cost of the project, rather than its end value and they will expect you as the developer, or your equity partners, to provide the balance of the funding.
The amount you can borrow is known as the Loan to Value Ratio or LVR.
Lenders generally class 2 or 3 unit projects as “residential” developments and use less stringent lending criteria for this type of project, whereas with larger developments they may require a greater percentage contribution of equity or a level of pre-sales.
Typically, you will need to provide 20 per cent of the funds for a 2 dwelling project and 30 per cent (or in today’s tougher lending environment up to 40 per cent) for larger projects, which lenders class as “commercial” loans.
So for a simple 2 townhouse or duplex development, you should be able to obtain a development loan at 80% LVR.
This means if your total development cost is $3 million, your financier will expect you to contribute around $600,000 of your own equity into the project.
Not unlike a regular residential new build loan, development loans offer staged payments to be finalised at the end of each regular building stage being;
- the deposit,
- base stage,
- frame stage,
- lock up stage,
- fixing stage;
- balance of development funds supplied on completion of the project.
Development finance is different to ordinary investment finance as usually you can borrow the ongoing interest as part of your finance package.
This means you do not pay interest during the construction phase of your project, but the interest is capitalised.
In other words, 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. However, you still won’t be able to exceed your total loan amount which will be, say, 80% of the development costs.
Once you begin marketing and on-selling your project you would then commence repayments.
If you intend to retain your finished project (my preferred strategy), you would pay out the development loan by refinancing the property and taking out a long term investment loan.
However, as explained) at no stage will the banks allow your loan to go above the agreed maximum percentage, such as 80 per cent.
You therefore need to show your lending institution that you will be able to service the loan, including the interest repayments.
This means you may require different types of lending for the various stages of a project, including;
- An acquisition or development loan to cover the purchase, development application and pre-construction costs.
- A construction loan to cover the building of a project and
- An investment loan if you are retaining your project as a long term investment.
Your Loan Application
To ensure you have the best possible chance of obtaining the development finance you require, you will need to put together a professional finance submission, a sort of “business plan” for your development project.
This should demonstrate to the lender that you can construct a viable project with numbers that “stack up” to make a financially successful development.
Loans for development finance require a detailed application, beginning with an executive summary that should point out the viability of the project and the design features of the development being considered.
Then each of following points should be explored in detail in your application;
- Site description
- Zoning
- Design Concept
- Resume of your property manager and major consultants
- Costings
- Feasibility study
- Projected sales figures
- Net result
- Timelines
Sources of Funding
Banks remain the major source of funding for developers and while most banks are keen to lend to experienced developers, however in the current stage of the property cycle, and in the wake of the 2018 Royal Commission into Banking, many of the major players are tightening their lending criteria.
As a result, second tier banks, private funders and joint venture funders are increasingly becoming a popular alternative for some developers.
Proficient mortgage brokers with the right expertise and knowledge can assist you when it comes to obtaining development funding.
Keep in mind that if you are undertaking a large project, your financing may need to be split over more than one lender and in this case particularly, a good mortgage broker can be of great benefit.
Pre-Sales
For larger projects most lenders require a certain level of pre-sales to minimise their risk of the development.
The percentage of the project they require to be pre-sold before they are prepared to hand over property development finance varies, but can be around 60 per cent. Obviously this is a way for lenders to minimise their risk.
By the way…you can’t use the funds from the pre sales to help fund your development – they have to remain held on trust.
Project Updates
Most lenders will require formal proof of budgetary and cash controls prior to and during the course of your development project.
This reassures them that you have done your homework and allowed for any budget blow outs or contingencies that may arise.
Before approving your loan, a lender may request all or some of the following elements;
- A fixed priced building contract
- Detailed construction costings from your builder or a quantity surveyor’s report
- Evidence of pre-sales in the form of deposits that are required to be held in trust. These deposits are generally cash to the value of 10 per cent of the purchase price.
As the project progresses you will need to keep your financier updated with;
- Progress claims made by the builder
- Reports from your project manager
- Cash flows and revised financial projections
- Any delays in the project
- Any changes to the feasibility study
- Any sales that may have occurred
Prior to making progressive payments to the builder the bank will require assurance that the particular stage of construction they are paying for is completed.
Sometimes they even require proof that the builder has paid all of his suppliers and trades so no claim can come back to the lender.
To ensure that the building stage has been completed the bank may send out its own valuer or request certification from a project manager or quantity surveyor.
What lenders look for
When assessing your development, project lenders look carefully and critically at the quality of the security you are offering; that is the end product of the development.
Their primary considerations in doing do so are;
- The fire sale price of the security. What would they achieve if they had to take possession as mortgagee and sell it?
- The end value of the dwellings you are building. If they are higher than the median price in your area they see these as lower quality security as they may be more difficult to sell.
- The zoning of your security. Residentially zoned land is the most highly regarded as it is the easiest to sell. Rural properties would be seen as less secure and hence the banks will lend a lower proportion on these.
- Lenders don’t like to lend against small apartments. If your apartment is less than 45 sq m the lenders will not be keen to lend on your project.
- The postcode in which your development is situated. Lenders prefer to lend against properties in areas that have a long history of strong capital growth and in large population centres.
- The usage of the security. Banks prefer to lend against the security of residential real estate compared to holiday resorts or serviced apartments.
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.
In Part 6 of our small development series, Bryce will consider how to source and secure the best potential development site at the right price.
If you want to learn more about the property development process you may be interested in How To Get Started in Property Development
You may also be interested in reading our Team Series or check out our graphic guide to the Property Development Process.
from Property UpdateProperty Update https://propertyupdate.com.au/property-development-finance/
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