Developing property may seem simple, especially in rising markets, but their are often surprises, unexpected costs and challenges that can erode time and profits alike.
Financing development for one, despite the low interest rate environment, is increasingly challenging and we want to share some brief insights from our customers that might apply equally to weekend “property flippers” or larger developers alike.
STARTING OUT
It would be too simplistic to say “do your research”, but proper planning at all stages of the process is the key ingredient for success. We touch on a few things here, though there is plenty more to consider.
Research and Feasibility is a key starting point.
Know exactly what type of asset you want to develop. Does this asset type bring with it any issues that impact building or prospects for council approval?
Location suitability is sometimes where many developers lose objectivity. Whilst experience in 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 the zoning maps, and get an understanding of the current development mood with the local council.
It is also important to consider any environmental issues, and any 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
Pre-sales are unconditional, arm’s length property sales that are made before construction commences. First tier financiers often seek 100% coverage of debt – including evidence of 10% non-refundable deposits held. This review will also consider whether the purchasers are Australian residents.
This is where the landscape for development has changed materially over the last decade, effectively post GFC. Primarily this is driven by both regulation, and to ensure a viable market exists before funding commences.
By requiring unconditional contracts that are also subject to legal scrutiny, it mitigates the risk of inflated bank valuations. This provides one of the foundations of how much the financier will advance. More on that below.
BANK VALUATIONS
Finance purpose valuations are complex. It will go beyond just the Gross Realisable Value (“GRV”) of the pre-sales, and 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 is obviously the most material component of Total Development Costs (“TDC”) which as a reminder, includes the land too.
IN ONE LINE VALUATIONS
This basis of valuation has adversely impacted many developers, especially the less experienced. What is it?
An in one line valuation is still a typical “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 then 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.
So make sure you discuss this with your financier upfront.
HOW MUCH CAN I BORROW?
It 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 as it is now can be divided into several tiers. First tier lenders (typically the major banks) not only require the pre-sales, but a more comprehensive review of project history (including marketing links), your financial position outside of the development, and the strength of the relationship with the builder.
Interest rates are at historical lows, though 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 intermediaries such as Ardent Lending Co., is that if development deals don’t quite meet first tier criteria, customers go from just missing out, to paying a considerable premium in terms of interest rates and costs. This obviously impacts the feasibility of your project.
That said, a non-bank or private funding option can you get your development going much more quickly. They will typically require less pre-sales, and offer a higher percentage of GRV/TDC.
WHERE DOES THE DEVELOPMENT FIT?
Of course developments can be for a range of purposes, more specialized property types will have more defined marketability.
On the smaller end, there is often some confusion as to whether the lending will be treated as a regulated residential 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). Many smaller developers will try and squeeze their credit needs through as regulated loans, and are often surprised when they are treated as commercial loans.
A commercial loan will mean a shorter loan term, higher costs and usually a premium in interest rate.
SEEING THE BIG PICTURE
There are many more considerations when developing property. The most successful property developers build a strong network around them, and leverage their relationships to successfully complete developments.
So some initial costs in the short term, especially in research and planning, can lead to better profits in the long term.
As an example, whilst non-banks or private lenders can be more expensive, getting your project completed more quickly could be a more profitable outcome in the long term.
For more information contact:
Ardent Lending Co. Team
W – www.ardentlendingco.com.au
M – 0448 591 731
