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Property development guide part 5 – Financing your project

In the fifth instalment of his series on property development  Bryce Yardney, Property Strategist at Metropole Property Strategists, 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 29117532 - piggy bank following money to a house isolated on a white backgroundthe development.

As a property developer you will have to understand finance and what the banks look for when lending for development projects.

Lenders look after their own safety first so when 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.

Therefore it is 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 some funding.

The amount you can borrow is known as the Loan to Value Ratio or LVR.  

investor-enquiry-form

Many lenders 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 for larger projects, which lenders class as commercial loans.

In other words, you will be able to obtain a development loan at 80 or 70 per cent LVR, depending on the size and nature of the project.

This means if your total development cost is $1.5 million, your financier will expect you to contribute $300,000 to $450,000 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. construction

Once you begin marketing and on-selling your project you would then commence repayments.

If you intend to retain your finished project, you would pay out the development loan by refinancing the property and taking out a long term investment loan.

However 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.

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;Your Loan 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, the truth is recent occurrences in the global market have seen many of the major players really tighten their lending criteria.

As a result, 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 50 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 contractProject Updates
  • 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? Hands of businessman
  • 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.



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About

Bryce is a property development specialist, having successfully completed many development projects for Metropole's clients. Initially working as a Project Manager at Metropole since completing his Bachelor of Project Management in 2011, Bryce now acts as a buyers agent for clients, sourcing and evaluating properties with development potential.Visit Metropole.com.au


'Property development guide part 5 – Financing your project' have 12 comments

  1. Avatar for Property Update

    November 3, 2012 @ 6:17 am willie sanudiya

    it’s shorter and detailed.

    Reply

  2. Avatar for Property Update

    March 8, 2013 @ 9:54 am Lizzy

    That’s cool, I kind of like it, it gave me what I wanted. Kudos to Gavin

    Reply

  3. Avatar for Property Update

    December 9, 2015 @ 9:45 pm Sudath

    Great article! We are just started doing a feasibility study for a property we have a contract. Can you recommend someone who can help with development lending?

    Reply

    • Avatar for Property Update

      December 10, 2015 @ 12:04 am Michael Yardney

      Sudath- yes it’s important to geta specialist in development lending. I would have thought your finance should have been in place before you went to contract

      Reply

  4. Avatar for Property Update

    April 27, 2016 @ 1:37 pm Damian

    Do any banks lend on the end value. to further iterate if I wanted to subdivide and build say 3 units with Say total value $1m and needing a loan of $700k all up giving me LMV of 70% in the end, could i get that loan out to pay for the subdivision costs or do i need a deposit upfront?

    Reply

    • Avatar for Property Update

      April 27, 2016 @ 1:40 pm Michael Yardney

      Damian – no it doesn’t work like that – banks want you to put in “hurt money” – you need more funds than you probably think

      Reply

  5. Avatar for Property Update

    May 31, 2016 @ 1:04 pm ella

    Hi, can you recommend a broker, or private funding organisation, we are wanting to buy property and subdivide it an onsell the whole site.

    Reply

    • Avatar for Property Update

      May 31, 2016 @ 1:59 pm Michael Yardney

      Ella
      Sorry – but there is currently little opportunity of making money buying, subdividing and flipping – that’s probably why you’re having difficulty getting finance

      Reply

  6. Avatar for Property Update

    January 5, 2017 @ 1:20 pm Arthur Jamieson

    I have an approved 8 townhouse site ….I own the property and have 30% of the funds required to build the project…The housing commission have shown interest in a long term lease of tge completed project….do you think the bank will finance the project on this basis?…would a letter of intent from the HC help secure the funding?

    Reply

    • Avatar for Property Update

      January 5, 2017 @ 5:58 pm Michael Yardney

      Arthur – the banks probably won’t lend you money ont he strength of an end tenant – they want to be sure you have the funds to complete the project and then if you’re planning to keep it as a long term investment -they will want to ensure you can hold the property under their current strict servicing criteria – which you probably won’t be able to.
      By the way…why have housing commission as a tenant? This would devalue your property.

      Reply

  7. Avatar for Property Update

    October 26, 2017 @ 9:10 am Frank

    If we already own the property, are you suggesting that we will also be asked to contribute 20% of the proposed development costs too in order to obtain construction finance?

    Reply

    • Avatar for Property Update

      October 26, 2017 @ 2:57 pm Michael Yardney

      Yes Frank – plus you’ll need to pay for all the “soft costs” that the banks won’t fund – consultants, fees, interest etc

      Reply


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