When developing property, there are often surprises, unexpected costs and challenges that can erode time and profits.
Finding finance for development is increasingly challenging for many aspiring property developers.
Below are some anecdotal insights from our customers that can apply equally to weekend property flippers or larger developers alike.
Starting Out
It would be simplistic to say "do your research", but proper planning at all stages of the process is a key ingredient for success. There is plenty more to consider, with the following being a good place to start.
Research and feasibility are key starting points.
Determine the type of asset that you want to develop. Does this asset have any issues that impact building or prospects for council approval?
Location suitability is an area where many developers lose objectivity. While having experience of living or working in an area you seek to develop has obvious benefits, don't allow this familiarity to forego the review of independent data (now readily available) to ensure your projections are reasonable and tested.
Despite local area knowledge, you will still need to study zoning maps and form an understanding of the current development mood with the local council.
It is also important to consider any environmental issues and adverse conditions of your site, including contamination. If the price of a potential development site is too good to be true, then it probably is.
Pre-Sales
A pre-sale is an unconditional, arm’s-length property sale that is made before construction is completed.
First-tier bank financiers often seek 100% coverage of debt, including evidence of 10% non-refundable deposits held. They will also consider whether the purchasers are Australian residents or foreign residents.
This is where the landscape for development has changed materially over the last decade. Primarily, this is driven by regulation to ensure a viable market exists before funding commences.
Requiring unconditional contracts that are also subject to legal scrutiny, mitigates the risk of inflated bank valuations. This provides one of the foundations of how much the funder will advance. (More on this below).
Bank Valuations
A finance-purpose valuation is complex. It will go beyond just the Gross Realisable Value (GRV) of the pre-sale and will consider a range of issues such as inherent risks and a deeper assessment of the development approval and proposed building works.
The selection of the builder will be one of the key parts of the process. Construction costs are obviously the most material component of Total Development Costs (TDC), which also includes the land.
"In One Line Value"
This basis of valuation can adversely impact developers, especially those with less experience.
An In-one-line-valuation is typically an "as if completed value". However, a discount is applied on the basis that the property would need to be sold to one buyer as a single sale. This obviously drives a lower valuation outcome than if each property were valued independently.
This means you should expect a lower valuation than if each unit were valued independently as a separate sale and security. In other words, a significant discount from the GRV that forms part of your finance approval.
Make sure you discuss this with your finance broker and financier upfront, as it can be a significant issue for many developers.
How much can I borrow?
Borrowing capacity will depend on the type of development, but typically up to a maximum 70 - 75% of TDC, or up to 60 - 65% of GRV.
The financing market is now divided into several tiers, but first-tier lenders (typically the major banks), along with pre-sales, also require:
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a comprehensive review of project history (including marketing links)
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your financial position outside of the development
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the builder's profile and the strength of your relationship with the builder.
However, bank margins are actually quite strong when you look through the fine print that includes their margin over negligible base rates.
One of the frustrations for those seeking finance is that if development deals don't quite meet first-tier criteria, the result is a considerable premium in terms of interest rates and costs from second-tier lenders. This obviously impacts the feasibility of a project.
That said, non-bank or private funding options can help you get your development going much quicker. They will typically require less pre-sales and offer a higher percentage of GRV/TDC. The number of lenders in this space is quite broad, which increases options substantially.
Residential or Commercial: Where does the Development Fit?
Developments can be for a range of purposes, with specialised property types having more defined marketability.
On the smaller end of the development scale, there is often confusion about whether the lending will be treated as a regulated residential finance credit loan. Most financiers will have restrictions on the number of units they will finance on one title, for example, typically a limit of around four (4).
However, many smaller developers will try to squeeze their credit needs through as regulated loans, and are often surprised when these projects are treated as commercial loans. A commercial loan for a development will mean a shorter loan term, higher costs and usually a premium in interest rate.
Seeing the Big Picture
There are many considerations when developing property. The most successful property developers build a strong network of suppliers and leverage their relationships to successfully complete developments. More content on property development can be found in our Property Guides for Victoria, NSW and South Australia.
Accepting some initial costs in the short term, especially in research and planning, can lead to better profits in the long term.
As an example, while non-banks or private lenders can be more expensive, getting your project completed quicker could be a more profitable outcome in the longer term.
Contact MCP
1300 510 816 or your Finance Partner
enquiry@mcpfinancial.com.au