What is Development Finance?
Property Development Finance (also known as “construction finance” or “development finance”) is a form of funding that assists with building multiple residential, or commercial properties. This form of funding is available through Australia’s banks, non-banks and private lenders.
What is Gross Realised Value (GRV)?
GRV (Gross Realised Value) is the ‘on completion’ value of a property development project. This is a common term used by many banks, and development finance providers and is used to determine how much borrowing they can extend. Most will fund against GRV, excluding GST.
What is Total Development Costs (TDC)?
TDC (Total Development Costs) is the complete sum of all the costs to purchase your development site, obtain the DA, construct (including contingency), marketing, sales as well as interest and holding costs. The TDC represents all the costs involved with completing a project.
Why You Use a Bank for Development Finance
In most cases Property Development Finance is needed if you want to build a block of units or townhouses. In the past, the only way of getting these funded would be going to see your local bank.
So you would need to go see ANZ, NAB, CBA, Westpac, St George, Adelaide Bank, Suncorp or any of the smaller banks and ask them for funding.
The banks would tell you how many pre-sales were required, the maximum TDC (total development costs) and GRV (gross realised value) and you’d be away.
In more recent times, the banks pre-sale hurdles have increased higher and higher.
For example, a major bank may want to see 50% of debt cover in pre-sales, but will only extend to 70% TDC. In other words, a developer needs to show $4m in pre-sales to cover the $8m in debt the bank was giving them.
Achieving this level of pre-sales in a slow property market can be very challenging for a developer.
Why You use a Non-Bank
Non-Bank lenders have grown into the property development finance space over the past few years, as the major banks have become more conservative in their approach.
So you can go and see La Trobe Financial or Trilogy Funds, they may say you can start the development with no pre-sales (or a much lower hurdle) and you could be ready to begin.
These lenders usually have a pool of money from individual investors, self-managed retirees or large investment companies.
The other advantage of using a non-bank lender is that they will extend a higher TDC, in some cases up to 85%.
This means you will need much less equity when compared to a bank.
But are there any other ways of getting started with less equity, or deposit?
Why You use a Private Lender
Private Lenders offer the most flexibility around both pre-sales and increased leverage.
This includes Mezzanine Funds, or what is sometimes referred to as Stretch Senior Debt.
There are private lenders who will lend up to 90% of TDC – they still want to see some money in there…
Private Lenders usually fund the loan themselves, so there is the most flexible around valuations, quantity surveyor reports and even sometimes with Directors Guarantees.
…but this flexibility often comes at a higher cost
Using a Private Lender for a construction loan is the most costly of the finance options.
Bank Finance (Senior Lenders)
For the banks, your past development experience can make a big difference.
If this is your first development the banks are going to want a lot more information than if it’s your 20th. However, experience is just one of the factors on how banks assess your request for finance.
How much can I Borrow?
- Multi-residential development: Borrow up to 75% of the total development costs (TDC), or up to 65% of the on completion, or gross realised value (GRV) excluding GST.
- Commercial Property development: Borrow up to 60% of the total development costs (TDC), or up to 55% of the gross realised value (GRV) excluding GST.
- Max Facility Limit: Up to $100 million.
- Max term: Up to 36 months
- Repayment Source: Interest can be capitalised
- Interest/Fees: Case by case, broadly 0.30-0.50% Establishment Fee and All In rate 5.50%-7.50% pa.
- Pre-Sales: Under $2M lending, case by case. Over $2M, 50-120% of debt cover.
- Residual Stock Lending: Case by case, depends on location and sponsor.
Different banks have different interest rate structures. Some will charge a Line Fee, others charge an All In rate.
What will be used as security?
- First mortgage over the real estate being constructed
- A General Security Agreement (GSA) over all your rights in relation to the security property, and all related pre-sale deposits held (this means the lenders see your pre-sales as their security)
- Full recourse director and shareholders guarantees
- A tripartite agreement between the developer, the bank and the builder.
What is their lending criteria?
As mentioned above, your past experience as a developer is key when working with bank finance.
The bank will want to review your project history, your assets and liabilities, understand your experience marketing projects, who you are working with, the suburb you are looking at building in and most importantly which builder you will be using to build the development.
There are many more factors the banks may wish to explore.
Who banks are useful for?
Banks are great for larger projects, over $5m in funding requirements and those which have achieved strong pre-sales.
Banks offer the cheapest funding because they take the least amount of risk compared to the non-banks or private lenders.
Non-Bank options
The non-banks and specialised development funders aren’t as concerned about your experience. They assess development finance more as a traditional asset lend.
And while non-banks do want to make sure you have enough money to complete the development, they are more concerned about the project itself rather than your experience as a property developer.
How much can I Borrow?
- Multi-residential development: Borrow up to 85% of the total development costs (TDC), or up to 70% of the on completion value excluding GST.
- Max Facility Limit: Up to $15 million.
- Max term: Up to 18 months
- Repayment Source: Interest can be capitalised
- Interest/Fees: Case by case, broadly 1.50-2.50% Establishment Fee and All In rate 9.95%-11.95% pa.
- Pre-Sales: Under $8M lending, nil pre-sales. Over $8M, case by case.
- Residual Stock Lending: Yes, LVR depends on location and sponsor.
Different specialised development lenders have different interest rate structures, which can be negotiated depending on your situation and the project itself.
What will be used as security?
- First mortgage over the real estate being constructed
- Limited recourse directors guarantees
- Can negotiate a limited General Security Agreement (GSA) over all your rights in relation to the security property, and all related pre-sale deposits held.
- Full rights and designs to any and all intellectual property held on the site
- A tripartite agreement between the developer, the bank and the builder.
What is their lending criteria?
As mentioned above, your experience as a property developer is less of a concern with specialised development funders. They assess every project individually, looking at the property itself, the suburb it’s in, and how saleable it could be if something were to go wrong.
The benefit of this is two-fold:
1) Non-bank lenders do not need to trawl through your financials, which as a developer can look amazing one year – and not as good in the next year while you are getting a project off the ground.
2) If you have a really good development project, in a desirable suburb that is harder to make pre-sales they can be much more flexible with pre-sales.
For example, if you are constructing 20 units targeted at Owner-Occupiers in Bondi – it’s going to be difficult to make pre-sales – compared to building 30 investment grade units in Albion.
Where a bank would take a broad brush approach to this, the non-banks and specialised development lenders can offer greater flexibility and understanding.
Who are the Non-Banks good for?
The non-bank specialised development lenders are perfect for small to medium sized projects. We find the sweet spot up to around 25-30 units or townhouses.
Not needing pre-sales means you can get your project started much faster, and potentially sell for much more as you won’t need to rely on expensive investment channels to make sales.
Private Lending
It is less common to do an entire property development using Private Lending due to the higher costs involved.
Interest rates usually start at 16% pa, and if it is a Mezzanine facility it starts from 20%.
For this reason, Mezzanine and Stretched facilities usually sit behind a senior bank or specialised development lender as a Second Mortgage. The Private Lender is taking more risk than the first mortgagor, and therefore charges for the increased risk.
This can also be structured as Preferential Equity (Pref) which doesn’t involve a second mortgage but may involve taking a share of profits. The benefit is that you can put in much less equity, or withdraw your equity before a project is completed to move onto your next development.
How much can I Borrow?
- Multi-residential development: Borrow up to 80% of the on completion value, excluding GST, or up to 90% TDC.
- Max Facility Limit: On application
- Max term: Up to 24 months.
- Repayment Source: Interest can be capitalised
- Interest/Fees: On application, broadly 2.00-5.00% Establishment Fee and interest rates > 16% pa.
- Pre-Sales: On application, generally nil presales.
- Residual Stock Lending: Case by case, depends on location and sponsor.
Senior Stretch Finance: One last private lending option
There are a few other common types of private lending including Senior Stretch funding and Land Bank funding.
With Senior Stretch funding, it is effectively private finance structured in a different way. It is priced based around risk, and is used when you may have made some pre-sales – but not enough to hit the banks target. In this case, the bank might allow you to start, if you put in more equity.
Who are Private Lenders good for?
They are usually suited to three types of developers.
1) A developer that is wanting to withdraw their equity before a project is completed, and move onto another project.
2) A developer who is slightly short of the funds required to start their project.
3) This type of product is good if you need to settle a site quickly and you do not have the cash ready.
Private Finance isn’t right for all property developers but can suit some situations.
Should I do a GRV or a TDC lend?
This is the biggest difference between the banks and the specialised non-bank development finance providers. For a lot of developers, a GRV (Gross Realised Value) Loan is more beneficial, although it costs more it has much higher leverage and lower pre-sale requirements.
Pre-sale Requirements
Pre-sales are unconditional, arm’s length property sales that are made by a developer before construction is completed. The banks need a 10% non-refundable deposit held in a solicitors trust account to consider the sale, a conforming pre-sale.
Why do the Banks require Pre-sales?
Prior to the global financial crisis, lenders rarely (if ever) required pre-sales. This is because residential developments were built on a much smaller scale than they are being done today.
In those days a project with 50 units was considered large, and at most might require 30% of the project to be sold before the bank would fund the construction.
These days a project of fewer than 50 lots or units wouldn’t be considered that big, and most large projects now contain 300 or more units making the lenders ask for pre-sales to cover 100% of debt.
The reason banks today need pre-sales are:
1. To prove a market exists for that development before they fund. Pre-sales set a line in the sand in terms of price for the completed units, and that buyers are willing to purchase what you are building.
2. Pre-sales form part of the lender’s security. In most cases, the lenders will push to hold the 10% pre-sale deposits in one of their accounts which they can hold, or keep if something were to go wrong.
3. Transparency of offers, and incentives. The banks will instruct their solicitors to review the pre-sale contracts to check there aren’t undisclosed incentives like cash rebates. These could artificially inflate the bank valuation, and affect their security.
What makes a Qualifying Pre-sale?
According to the bank’s own facility agreements, pre-sale contracts are to be exchanged on the following basis:
- Unconditional arm’s length contract in a form and substance acceptable to the Lender. Unconditional means other than completion of the Project and issuance of the Certificates of Title, including no entitlement for the purchaser to rescind the contract should the Borrower be placed in liquidation or another form of administration, or should a mortgagee assume control of the Project for any reason;
- Maximum of two residential units per purchaser and a maximum of four foreign purchasers (Australian citizens living and working temporarily in a foreign country not included);
- 10% non-refundable deposit to be paid by either (i) cash and held in a solicitor’s trust account with the Lender’s interest noted or (ii) Bank Guarantee;
- Bank Guarantees are to be provided by an established financial institution satisfactory to the Lender. Deposit Bonds provided by an issuer acceptable to the primary lender up to a maximum of three;
- No pre-sales to be rescinded/cancelled without Lender’s written consent;
- Internal sales to the Borrower are to be assessed by the Lender on their merits to ensure that any arm’s length transactions are treated as valid pre-sales; and
- The value/number of pre-sale contracts exchanged are to be confirmed to the Lender by the Borrower’s solicitor on a monthly basis.
Development Valuation
One of the most critical parts of the entire development process is valuation. A low valuation can be a show stopper for a planned development because it makes it harder to receive funding.
What information do you need for a Development Valuation?
The lender’s valuer will complete a comprehensive report on your project, it usually contains:
- Property details, zoning and title information
- Expected as if complete value, and current as is value
- Risk profile and analysis of the development approval, property and market
- Review any environmental issues, and recommend further reports if the possibility of contamination
These reports are approximately 100 pages long, and determine if the lender will approve (or decline) your loan.
For this reason, the Property Valuer will need copies of:
- Council and infrastructure charges notices
- Building specifications and internal fit-out/finishes
- Unit floor areas and/or preliminary survey plan (if available)
- List/asking prices for the proposed units
- Pre-sale contracts for the proposed units including any special conditions (if applicable)
- Building contract
When do you need an ‘In One Line’ Valuation?
An ‘In One Line’ valuation is where the valuer completes the as if complete value, and then discounts the total figure to assume the property would need to be sold in a single transaction, to one buyer.
Typically we find an In One Line valuation includes about a 15-25% discount from the gross realised value. In other words, if your property development of 25 units has a GRV or As If Complete value of $11.250M.
If it was valued In One Line, the GRV would be discounted by 25% to reduce it to $8.437M ($11.250 – 25%).
As a developer, this isn’t particularly helpful because it means your lending will be based on that lower figure. So make sure you know how the bank or lender is going to value your property and check that the figures work before you go spending a few thousand dollars on a useless valuation.
Information needed for Development Finance
Doing property development involves a bit more information than when you are building a house.
Obtaining Development Finance approval requires you to hold the Development Approval (DA), and ideally have a building contract in place.
What information is required for Development Finance?
At a high level, we will need to put together this information for your project:
- Location and number of units in the development
- Estimated ‘as is’ value (purchase price) and outstanding debt (if any)
- The estimated market value ‘on completion’ or expected sales revenue
- Construction Costs
- Term required
- Pre-sale details (if applicable)
In addition, we will need to collate a Credit Submission for the bank or lender that covers:
- Developer – Detail Background and experience
- Projects Completed – Provide details of the last 4 – 6 projects and who were the finance providers
- Details about the Project – Location, unit details etc
- Copy of the DA (development approval)
- Copy of the Plans
- Feasibility of the Project
- Copy of builders Contract
- Profile & Resume on Builder – Including details of their last 4-6 builders.
- Business Finance Application (Includes Statement of Position for each Director )
- Group Structure – If more than one entity involved
- Copy of Trust Deed if applicable.
- Rental Appraisal on Units being developed
- Copy of pre-sale Expression of Interest (EOI) or contracts prior to being be signed by the purchaser. (Bank Solicitor to review to ensure they meet the bank’s requirements)
So realistically you will only be in a position to apply for Development Finance once you have your DA, and all of the information together.
Finance Process
Even before you have your DA approved, you can contact our team to discuss what the lender funding table will look like. We can give you an idea on how much equity you’ll need if you go through a bank, or a specialised lender.
Assuming you have your approvals in place and are ready to move forward with funding the finance process is:
- Workshop scenario and quote funding options – In the early stages, we can help workshop your development finance scenario. This generally starts with your feasibility, which we can translate into a bank funding table to give you an idea on what equity and pre-sales may be required. At this stage, we can start high-level discussions with various banks and lenders, but it isn’t wise to start shopping the market until you have all of your information together.
- Lodge application with lender – Once you have your DA, and builder lined up we will put together a detailed credit proposal for the lender. This will summarise everything their credit team will want to know – from the project overview to the risks and market summary. We will also conduct discussions directly with Senior Credit Managers within the banks, and lenders to get a direct understanding of their view on the project.
- Lender completes initial assessment – In the previous stage we would have tendered the market, and chosen a lender (or lenders) to proceed to obtain credit terms with. Depending on the project size, and complexity we can look at getting terms from multiple lenders to help make sure you have the best possible deal.
- Indicative Letter of Offer issued – The lender will assess your development finance application, determine it meets their credit criteria and issue an indicative term sheet. This is usually subject to further verification, valuation, Quantity Surveyor (QS) and hitting pre-sale criteria. The benefit is it gives you an idea on what the banks are looking for, the downside is that these term sheets are non-binding, so the banks are not bound to proceed with funding your project. We have seen lots of developers get caught out on this, by having all of their development funding with the one bank.
- Valuation and QS Initial Report – Experienced developers tend to get the valuation earlier in the process, even before approaching the banks to gauge where the valuer’s will put the revenues and potential sales figures – while other developers will wait until they have made some pre-sales (to prove the market) before getting the valuation. Either way, this is a critical part of the process and one that must be done correctly. It is also at this stage you can get the Quantity Surveyor (QS) report, which is required for any construction works over $900k.
- Lender completes Formal Assessment – With your valuation and QS report in hand, its time to go back to the lender and obtain formal approval. In many instances, the developer hasn’t hit their pre-sale hurdle yet, and the banks will formally approve the facility subject to satisfactory pre-sales. This is where a Stretched Senior facility can help with getting your project started faster.
- Lender issues a Letter of Offer and sends Legal Documentation – Once the facility is formally approved the lender will issue their letter of offer outlining the terms of the facility, and get their solicitors to issue the loan document – like facility agreements, GSA’s, directors guarantees and builders agreements.
- Lender completes Settlement – When the facility documentation is returned, and all pre-settlement conditions have been met the bank or lender will proceed to complete settlement and advance any funds required at this stage.
- Project Monitoring and Progress Payments – Being a development facility, and similar to a construction home loan the facility is structured to be progressively drawn down. The lender will make monthly progress payments to the builder, this process involves the Quantity Surveyor signing off the works completed before the lender released payment.
Need help with Development Finance?
Having worked with several of the large banks, we understand how their internal credit policies and processes work and can help navigate your project through to completion.
Get your project started faster, and with no pre-sale requirements by talking to our team today – contact us on 1300 931 892 or request a call from our staff.
