Michael Yardney, director of Metropole Property Investment Strategists has been involved in property development for more than 20 years. His company is currently development manager for over 110 residential projects across Australia. Yardney’s first piece of advice for prospective developers is to remember that borrowing for development is very different from borrowing for investment.
Financing property development is a lot riskier for lenders and therefore their requirements are more stringent. If you don’t have much experience in the field, banks may baulk. Yardney suggests that until you get a good reputation or a good track record, you should either bring an experienced person into your development team – such as a project manager or development manager – or use a good mortgage broker, “because they’re going to understand what the different lenders’ requirements are”.
Every lender also has its own ideas about what constitutes a feasible project. The level of equity required, the profit margins expected and the risks they are willing to take will vary widely. Some lenders draw a distinction between ‘residential’ projects and ‘commercial residential’ projects – the difference lies in the number of units to be built.
“To ensure that you do get your development finance quickly, you need to put together a much more professional finance submission – a sort of business plan for your development project – which is different to a normal investment proposal,” says Yardney. “This shows the bank that you are aware of the need to have done a detailed feasibility. It also protects you.”
Your submission should start with an executive summary, outlining the broad scope of the proposal and the amount of money required. A thorough feasibility study should come next – but you can’t just punch random figures into an Excel spreadsheet and then massage them until they show the required profit margin. You need to show your working.
“You’ll be projecting sales values, building costs, etc,” says Yardney. “You’ve got to explain how you’ve come to those.”
To increase your chances of success, the suburb you’re looking to develop in must show strong demand and have good access to infrastructure and transport. Lenders will definitely take these features into account.
The valuation process
Once your lender is satisfied that the numbers look reasonable, the valuers will be sent in. Unlike the valuation for a simple investment property purchase, the development valuation process is always exhaustive. A professional valuer from the bank’s panel of independent firms will be appointed, and they will certainly uncover any lurking snags that could potentially derail your project.
The valuer will go through your feasibility study with a fine-toothed comb and ensure that you have included all of your expenses. Even if you’re not planning on selling the project, they will include selling and agents’ costs, just in case you default and the lender needs to liquidate.
“Then they want to see a commercial margin, which is sometimes 15% or so,” adds Yardney. “In other words, after all those expenses, they still want you to be making at least 15%.”
In the current environment, lenders have become increasingly allergic to risk. “Lenders are money shops,” says Yardney. “They want to lend their money, but they want to protect themselves.” There are several reasons a bank might turn you down.
“We would decline applications with financially weak sponsors, or what we view as poorly planned projects,” the St.George spokesman says. “Additionally, if the margins are tight and/or the potential length of time in the development might impact on the success of the venture to capitalise on the prevailing market conditions, we would not be in a position to accept the application.”
Even if a bank does accept your application, any one of the following errors could leave you exposed to a cost blow-out or even a mortgagee repossession.
- Cross-collateralising. “It’s a common mistake for developers to cross-collateralise their development loan with their existing properties,” says Yardney. “In other words, they use their own homes as securities for the development. This causes difficulties when you want to partly discharge the mortgage.” If you are using existing equity, it is much better to take the money out of your current property, use it as a deposit and borrow on a standalone basis.
- Running multiple development projects through the same entity. “If you do this, the banks will, by default, have access to other projects. In some ways, it’s like cross-collateralising,” warns Yardney. “You should run different projects under separate companies.”
- Leaving out expenses. This is where some developers cut corners in order to present a more attractive business plan. Big mistake. Most costs are quantifiable and a little hard work and research should ensure that you have provided for every eventuality.
- Insufficient contingency. “One of the most common mistakes developers make is undercapitalising their projects and getting stuck near the end,” says Yardney. “You have blow-outs or interest goes up or the project takes longer [than anticipated]. It all starts well but right at the end you use up your line of credit and you’re stuck.” Remember that circumstances will almost certainly change. When you think you’ve got enough money in your contingency component, add a little more.
- Unrealistic expectations. “What [the lenders are] wanting to see is that it’s going to be safe and easy to sell,” says Yardney. “They’re going to look at fire-sale price for security. The bank will never value it at what you think it’s going to be – they won’t look at it in the same rose-coloured glasses as you will.”
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