Understanding the basic principles of finance can give you a really big head start in obtaining property development finance. Even before this process something that everyone should consider before attempting is this-start with the end in mind.
What this means, is that you really need a good understanding of who will be purchasing this proposed development and at what level of finish/quality and expected rental as investment will be needed to sell out. In other words, you wouldn’t be putting platinum taps into a budget townhouse complex, and to show when it goes right, we will offer a client scenario a little later.
The basics of property development finance are loan to value (LVR) ratio, owners’ equity or equity held in the land, additional cash flow resources other than pre-sales, marketing and sales costs, development approval (DA), building approvals (BA), preparation of land (headworks), and all the associated professionals fees. These can include feasibility studies, town planning, architectural, building surveyors/certifiers, engineers, finance and in some cases the list goes on.
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It is because beginners don’t understand the significantly bigger jump from buying land and building or renovating a home or townhouse and can find themselves in hot water quickly, with a lot of money going out before realizing any coming back the other way. This then explains why development finance is not without risks-many moving parts, and why many lenders have a much stricter approach to assessing the capabilities of the developers or sponsors as lenders call them, before offering a loan term sheet.
They are looking for experienced persons with a previous history or portfolio of successfully completing projects. These don’t necessarily have to have been large scale projects at the outset, but will need to show that they can maintain a budget previously and a sellout position that will close out the project for the funder.
Unlike home loan lending, these are short term options generally with the land component held as security and a construction expected to be finished within two years. This therefore requires a detailed feasibility study, which clearly represents all costs considered and potential profitability of the whole project. Having all the associated documents representing the items detailed earlier goes a long way to achieving successful finance or funding options for property development finance.
That all depends on how much equity is in the land and how much equity the sponsor will be contributing. This is clearly project dependent and the funder will be looking to see that an agreed level of LVR ratio is met during the course of the staged development if there is going to be stages. Say the development will need to meet a maximum of 60% LVR during the course of the build/development (works), at any particular point then available equity and sponsor’s contribution will need to be evident.
There have been many significant changes over the past year and a half. First, with bushfires some of which commenced in August 2019 through January of 2020. Followed by the flooding. Then the Covid-19 from March 2020. This has left many lenders concerned about the state of the housing market.
Ironically, what has happened during Covid-19 episode has been a move by many individuals and couples towards purchasing house and land as opposed to being stuck in a unit during lockdown. This has effectively caused an increase in many areas of the housing market and has meant that construction will likely surge over the coming two years. Therefore, a great time to be developing, particularly given a lull in the property sector for the market for the past several years and the difficulty in obtaining finance for projects.
Now to the example mentioned at the beginning of this page, what follows is from an actual deal-simplified:
So in this case one million made for 2+ years work utilising original equity, so it shows what can be achieved from even basic developments when managed correctly.
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