Development Finance Overview

dangerFor beginners, financing a development appears to require knowledge of some type of ancient ritual to make sure that all the planets align for a banker to say yes. Well, it’s not quite so esoteric, but it does take a little getting used to.

Development financing is usually provided on the basis that the borrower has been able to gain an approval from local authorities to either develop a land sub-division or build houses or an apartment block. You can also obtain development finance for smaller projects such as say 4 townhouses.

There are some key items that the bank will consider when assessing your application:

Sponsor Risk

This is you, or the applicant for the loan. Who are they, what have they done before, what is their net worth, their experience and their ability to complete this development?

Lenders want to know that the people they are dealing with have completed similar projects before, that they know what they are doing. They also want to see a reasonable asset base behind them. If something goes wrong on the development and the costs suddenly blow out because of delays or unforeseen circumstances, how will you cope with that?    Do you have other assets you can liquidate or cash you can inject into the project?

Construction Risk

The builder you employ is extremely important.Are they also able to complete this project and how many others like it have they done?   Are they are large builder or a small builder?   Are they working on too many other projects at the moment and their resources are spread too thin?

Financiers also prefer you to have a fixed priced contract in place for your construction. This means that most of your construction will be covered by a contract that states a total price for delivery. A fixed price contract gives you and the financier some certainty over the cost of the project.

Sales Risk

If you start talking to a financier about a development they will ask you about pre-sales. Pre-sales are achieved when you have sold a block of land or a unit or house that has yet to be built. For many people you will know it as ‘off the plan’. Just take a trip to the Gold Coast in Queensland and you can talk to plenty of people about ‘off the plan’ sales.

Pre-sales are not a bad thing.  The reasons that financiers want you to have them is that they are an indication that the market (ie. buyers) like your product and are prepared to buy it. Also having a certain amount of your product sold is like ordering stock when you own a shop. If you already have half of it sold, then it gives you much more confidence about spending the money on the stock. The same applies for financiers.

The down-side of pre-sales is that you might have offer your stock (land and apartments etc) at a lower price than what you could achieve if you had your development completed. This is because many buyers do not want to commit to buying something that they cannot see and touch. Also, in the first few sales you might be selling to property speculators. These buyers are purchasing your property on the basis that they think the value of the property will be higher when you are finished and they will achieve some type of capital gain from the uplift. Speculators want your product at the cheapest possible price and will make offers below your list price knowing that you need pre-sales to get your finance.

In most cases you need enough pre-sales to cover at least 75% and perhaps up to 100% of the amount you need to borrow from the financier.  So, if you need to borrow $2M and you are selling your apartments at $500,000, then you need to sell 4 right?   Well, almost right.

On the next page you can learn about the numbers of development finance. The amounts you can borrow, how they get calculated and how to work out whether your finance will get approved. I’ll also tell you about non-bank finance or private lenders that can provide funding without some of the strict rules of banks.

 

 

 

 

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