Property development brings more potential financial rewards than traditional property investment, but it is not without risks. Before you commence any development project, it is crucial that you establish the amount you can borrow and a plan to manage all of the associated costs.
To become a property developer, you first need to understand finance and what banks look for when lending. We will guide you through property development finance options and the risks and mistakes to avoid along the way.
Banks won’t simply lend based on the security of the project. They are going to want to establish a track record of the people behind the development. What this means, is that until you develop a good reputation with the bank and a sound track record in property development, lenders are going to assess your development team as well as the finance presentation.
Generally, a development loan is structured so that the lender provides up to 70-80 percent of the final cost of the project. And, they ill expect you as the developer to provide the balance of the funding. The amount you can borrow is what is known as the Loan to Value Ratio or LVR.
Typically, you are required to provide 20 percent of the funds for a small development – such as a duplex home – and 30 to 40 percent for larger projects. If you plan to develop a townhouse or duplex, you should be able to obtain an 80 percent LVR development loan.
Similar to a residential new build loan, a development loan requires staged payments to be finalised at the end of each building stage. Such stages include:
- The deposit,
- Base Stage,
- Frame Stage,
- Lock Up Stage,
- Fixing Stage, and
- Completion of the project.
Unlike a residential new build loan, a development loan does not require you to pay interest during the construction phase of your project. However, the interest is instead capitalised. What this means, is that the interest is added to the amount owed at the end of each month. So, the next month you pay interest on your interest.
If your intention is to retain your completed development project, you pay out the loan by refinancing the property and taking out a long-term investment loan. To do so, you must be able to supply your lending institution with documentation proving that you will be able to service the loan (including the interest repayments).
In summary, throughout the process of your development you may require different types of lending for various stages of the project, including:
- A development loan (or acquisition loan) to cover the purchase, application and pre-construction costs.
- A construction loan to cover the building costs.
- An investment loan should you choose to retain your project as a long-term investment.
When assessing the feasibility of your project, it is essential that you keep the lender’s criteria in mind. Unless your project ticks the correct boxes for a bank you will struggle to secure finance.