How Does Multi-Unit Development Finance Work?
The first step in financing a property development project is quite logical. You need to figure out how much the bank will lend you, and how you’re going to maintain loan repayments.
Note that how much the bank will lend you for a development project is potentially different to the amount they will lend you for a more simple property investment.
For the banks, lending to a developer is a very different assessment process. The risk with a development project is greater as the final build cost and sales values can only be estimated initially. The banks will consider both the viability of the project as well as your own financial history. Even the track record of your builder may be taken into account. In cases where serviceability of a facility becomes an issue, banks may also ask for off the plan sales before releasing funds.
Your loan application
Your loan application will be similar to an in-depth business plan. How you manage the application process will also influence your reputation with your lender. You’ll need to put together a detailed application that includes the following:
- Executive summary (project viability and notable features)
- A viable timeline
- Feasibility assessment (including contingencies)
- Complete costings: construction costs (which in some cases a bank may request a quantity surveyor report detailing this information), loan payments, interest payments, legal fees, tax payable, projected sales figures, and net result
- Site description
- Zoning details
- Design documents
- Details of your consultants
Your application needs to adequately display the viability of your proposed property development project. Lenders are looking critically at this information to determine the risk level of your project. In addition to the current project viability, they will also analyse the quality of your security. This includes the:
- End value vs median value (a higher than median value home is more difficult to sell)
- Zoning (residential zoning is preferable)
- Fire sale prices (what is the minimum they could sell for)
- Dwelling size (small apartments are not easy to fund)
- Suburb capital growth
Most development loans are up to 80% of the final cost of the project. The remaining is funded by your and/or your equity partner/s as a deposit. If you need to borrow more than 80%, you will need to pay for Lenders Mortgage Insurance (LMI), and the approval process will usually be more difficult. The amount you borrow is called the Loan to Value ratio, or LVR.
It’s important to know in the planning process that how many units you want to build will affect your loan. This is because the classification of your project changes the allowable LVR. ‘Commercial’ projects LVR is often only 60-70%, whereas it can be 80% for ‘residential’. However, just because a project is called ‘commercial’ doesn’t mean it’s a commercial property. A development project is classified as ‘residential’ where there are 2 or 3 units on a lot. Whereas over 3 units may be deemed a ‘commercial’ real estate development.
Development loan finance packages
Where a property development finance package can differ from a simple investment is in regards to the interest payments. You may be able to borrow the interest payments within the loan. In practical terms this means that instead of paying the interest in month 1, this gets added to the total amount for month 2, and so it goes. That is, as long as costs remain within your maximum LVR. This may continue for the entire construction period, and would usually end upon completion.
Property development loans are usually staged payments. These are payable by the bank to your builder at the completion of each stage, and include:
- the deposit
- base stage
- frame stage
- lock up stage
- fixing stage
- balance upon completion
As the process of gaining development finance can be complicated, it’s advisable to get assistance from a specialist team early on. An experienced multi-unit design and construct team should be able to assist you with the information you need for your application. They may also be able to link you with other specialist services such as mortgage brokers experienced with development loans.