Development Finance

Development Finance can be used to describe the construction of a duplex or an apartment block of 240 units.   For each of these projects the rules of banking remain relatively the same.

If the developer applying for the finance wants the cheapest interest rate and fees, then the conditions of the loan will be much higher.  If the applicant is willing to pay more, the conditions will be less.   To explain further, it’s best to divide the financing of projects into two camps, vanilla banks and non-bank finance companies or individuals.

First though, some basic numbers that are rules of thumb to check if a development project qualifies for finance.

Rule 1:  The finance available will most likely be 65% of the Net Realisable Value of the project or up to 80% of the cost of the land and the construction.   The Net Realisable Value (NRV) is usually the Gross Value (240 units multiplied by average sale price of $700,000) less GST on the project.  Sometimes the cost of marketing the project is also deducted from the Gross Value (GRV) as well.

Rule 2: If the applicant owns the land unencumbered, it’s likely they have enough equity.  The land value in most projects is typically 30% of the total cost.  If the applicant owns this land, then they generally have sufficient equity.   However, they may still need to have extra cash available.

Rule 3:  If you pre-sell 60% of the product, it will often cover 100% of your debt.   Presales are important in a project.  They de-risk the project from both the financier and the developers perspective.  Bank’s will always expect pre-sales, private and non-bank financiers don’t always need them.  100% debt coverage is a general rule to be met by banks.

Assuming a project meets at least Rule 1 and 2, then an application for finance with a non-bank funder could be put together.

Let’s say that in order to be approved with a major bank at 3% per annum, the applicant must pre-sell 60% of their 10 Unit Development.  A non-bank offers the finance at 10%, but doesn’t need pre-sales and the project can start immediately.

The developer may need to drop their prices by say $20,000 or more to get their 6 presales, adding up to $120,000 in lost revenue.   If the cost of this discounting is more than the interest difference between the 3% and 10%, then a comparison on interest rates is not worth having.

Many developers like to get their projects started and non-bank financiers are willing to risk their money in particular market-places.  Bank finance will always be much less expensive, however, the conditions that sit alongside cheap money may well not be worthwhile in the overall equation.

To qualify for development funding, a finance company or bank will always consider the following

The Project / Sales Risk:  Does it make sense, can it make more than 15% IRR.  Is it pre-sold, is its location attractive?

The Sponsor:  Has the applicant developed before, on time and on budget, are they credit-worthy?

The Construction:  Is it a fixed price contract, have trades been locked in, can this builder complete it?

Providing as much information about these three risks as well as the feasibility will be the start of a good proposal.

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