Development Funding – What To Know About Developing Property Apartments/Units and Townhouses
Building a large-scale development gives you a way to maximize your investment profits for one lot of land. However, borrowing funds to help finance this development takes time. It can be challenging to pick out the correct loan and funding channel and having a good understanding of the options available is essential.
Defining Development Funding
Development funding is a type of loan that the borrower uses to fund a construction project. This type of project involves building several properties all under one title. This funding splits into two categories depending on how many and which type of residences you want to build. Developments that have up to four units, including townhouses, duplexes and triplexes can secure funding through a residential development funding. Larger projects require that you secure a commercial development loan or funding.
Two Types of Development Funding
One of the first issues you’ll run into when you start looking at development funding is whether you need a commercial or residential loan. The main deciding factor between these two different loans depends solely on the number of properties you intend to build.
A residential loan is typically easier to get with a more simplified application process. As we mentioned, the restriction is four buildings and below to fall into this category. If your property development project goes over four buildings, you’ll have to secure commercial funding. Going this route will have a large impact on the paperwork you fill out and the documentation you’ll need to get your commercial development funding. Additionally, it can impact the loan features that you’ll be able to use and also the type of lender you will need to use. For large multi-unit development, non-banks and private funders are a great option, they are easier to deal with than the major banks and require less pre-sales than the traditional 100-110% debt coverage required by the big banks.
A commercial loan will also have a higher interest rate associated with when you take on large-scale developmental projects. There is also a different fee structure that works with residential development funding. Financial institutions take a more conservative approach to the sector of commercial lending. This means more details and more information along with meeting the standard requirements for a residential loan.
The Development Funding Process
Development funding work similarly to residential construction loans. The financial institution won’t release all the funds as a lump sum. Instead, they’ll release portions of it at progress payments for each stage throughout the build. While this happens, the total interest due is usually payable at the end of the loan term. At this point, the developer would want to have amassed pre-sales during the construction process to help cover the construction debt. The borrower is also able to refinance or convert the debt to other financial institutions as a residual stock loan or as individual lots, using the funds to pay and close down the construction facility.
The main variables to consider when looking at your lender options to start your development project are how many pre-sales you have and your loan size. The more important variable is pre-sales. Pre-sales are the amount of sales you have made for your project off the plan, prior to commencement of construction. Lenders see these pre-sales as ‘debt coverage’ and are almost guaranteed to go towards paying back debt at the end of construction. If you have 100-110% pre-sales of your total project, the big banks would be a great fit for your funding. However, if you have struggled to meet the big banks pre-sales requirement, there are non-bank and private lender options.
Non-bank and private lenders are more expensive however, they are much easier to deal with and have less strict requirements. They look at projects on a case by case merit and consider minimal pre-sales. Depending on the lender, some allow for 50% debt coverage or we have lenders who can consider no pre-sales at all, however these lenders are much more costly.
Once a lender has been located based on your pre-sale’s requirements and loan amount, they will want to have the following documents organized to work out a funding table and ensure the project is safe to fund:
An ‘as if complete’ valuation will need to be ordered by a valuer on the banks panel. This valuation is a very crucial element to the project approval as the lender will only lend a percentage of this valuation depending on the project (usually between 50-80%). A valuer will look through things such as the finish quality, comparable sales and site plans and provide the value of the project upon completion. Should the valuation not come back strong enough within the required LVR, the borrower will be required to have the shortfall funds available for the lender to proceed.
The lender will need to sight the building contract and ensure it is to standard. The building contract will assist the lender on the cost of the project and at what stages the funds will be used. The contract outlines all roles, rights and responsibilities of the parties involved and, in the case of disputes, how they should be resolved. A contract should include everything that has been agreed on, including the time frame for the work to be completed, what the work is, the contract price, how and when the payment should be made, what happens if there are delays and how to manage the process, how to manage variations to the build and how to manage any matters relating to the build that could lead to disputes.
Quantity Surveyor’s Report
During development funding, lenders release funds based on the builder’s contract and the QS report (Quantity Surveyor’s Report) – usually the lender refers to the lower of the two. This report discloses all your costs associated with your building project. It will help you avoid common pitfalls like broad estimates, not having accurate cash flow analyses and they can steer you away from unnecessary risks to help reduce the amount you borrow. There will be a total recommendation of how much the project will cost and it will be broken down in stages.
If there is anything left over after the construction, the lender will release it to you when you complete your development project, or it will be used as contingency. Having the loan set up like this ensures that your contractors get their money at every stage of the development building process.
The lender will want to sight and pre-sale receipts with valid sunset dates that don’t go beyond the build term and the lenders usually prefer any pre-sale purchasers to be Australian Citizens with the deposits held in a trust account. The amount of pre-sales will help determine the LVR of the loan, the fee’s payable and what interest rate you will pay.
Council Approved Plans, Schedule of Finishes and Building Permits
These documents are standard and are needed by the lender so they can ensure you have completed the necessary steps to have the project ready for construction. Your engaged builder will assist with these documents.
Alike a standard mortgage, you will have to follow an application process to prove to the lender that you can service the debt you will be taking on. This can determine which funding channel you use as major banks will want to see traditional income verification documents such as tax returns. Private lenders and non-banks don’t usually request for any income proof however may need a letter from your accountant confirming your income.
Development Funding Features
Depending on the type of developmental funding you choose to get for your upcoming project, these loans come with features that borrowers have to seriously consider before they proceed. These features include but are not limited to:
The Way You Pay Interest
The way you pay interest with development projects is a little different to your traditional mortgage. When the lender is assessing the project, they will complete a funding table and assess the total monies required to set up your facility. They will take into consideration the money required to complete the project, the application/establishment fee, legal fees, mandatory contingency funds and the interest owed on the borrowed funds for the required loan term. The lender will set up a facility of the total monies required; this facility will need to be within the required Loan to Value Ratio with any shortfall to come from the applicant’s pocket. Rather than paying interest as the build goes on, the lender ‘sets the interest aside’ and simply requires the interest to be paid by the end of the loan term. This is usually covered by pre-sales or the completed apartments are refinanced to individual banks to pay back your construction lender what you owe. Not paying the interest monthly assists the projects cashflow as the priority is getting the project complete within the time frame.
Loan-to-Value Ratio (LVR)
The maximum amount of money the lender will let you borrow depends on the lender itself, your loan amount required, your project complexity and the amount of pre-sales you have. The LVR can be anywhere between 50-80%. Our brokers will assess your project and line up the most suitable and cost-effective lender depending on your personal and project’s circumstances.
Higher Interest Rates and Establishment Fee’s
There is more risk associated with these types of loans, and this means you’ll pay more. Depending on the lender, loan size, LVR, pre-sales amassed, and project complexity will determine the interest rate payable. This is usually upwards from 7% p/a for the term of the loan for major banks, 10-12% for non-banks and private lenders. The establishment fees are also higher than traditional loans due to the complexity of these deals and work involved, this can range from 1% of the loan amount upwards.
Restricted to Labour and Material Costs
Development funding usually has restrictions to “hard” costs. These costs are for labour and materials required to complete your project. Other costs like DA approval, architect fees and council fees don’t fall under this category. This means they’ll come out of your pocket, and you must budget for them when you outline your development costs.
Contact Us Today!
If you’d like help tailoring your development funding loan, we can help. We invite you to reach out and get in touch with our staff. We’re ready and willing to help you choose the correct loan and secure the best type of loan possible for your project. Contact us on on 02 9121 6247 or submit your scenario online.
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