First time developer

01/03/2012


Question: I am a young property investor and I have just secured my second investment property. It’s a house on a block that’s large enough to subdivide into two units, which I think is realistic for me as a first time developer. I’m unsure, however, whether or not to sit on my properties see where they take me, or to start developing now. My main issue is that I don’t know where to start with getting the funding. How can I go about convincing the bank to lend me more money as a first-time developer with no successful projects behind me to prove to them that I know what I’m doing?

Answer: As with any property investment, how you proceed depends entirely on the numbers in the deal, and this is no more critical than when applying for finance.

The bank’s primary objectives are to get the money back, and make a profit from the interest earned. It is less concerned about the applicant than it is about the application.

The applicant does play a role in the approval process, but as a secondary concern. If the deal works under its own merit, the bank will look at the applicant and see if there is additional risk to getting the money back or making a profit. If the applicant isn’t an additional threat, the loan will likely be approved.

If the deal doesn’t stand on its own merits, then the applicant becomes a critical part of the equation for approval. The bank will rely on the applicant independent of the deal to be able to service the debt and pay the loan back. So it comes back to the numbers in the property development deal.

Let’s now talk about the application with respect to mitigating the bank’s risks, and therefore increasing your chances of lending approval.

Let’s say you go to the bank with a proposal for the property that you want to build two units on. What are your choices?

Option 1:

  • Rent for six months, put in plans and permits and get them approved.
  • Once approved, get an artist’s impression of how the finished units will look, and sell the two units off the plan.
  • Once sold, research and select a builder to undertake and manage the construction. Get a fixed price quote for the entire completed works that fits the sale price and delivers the expected unit quality.
  • Armed with signed sales contracts and fixed price complete quotes, go to the bank for a construction loan.

Here are some example numbers. Please note: these numbers are simplistic and used specifically for demonstrating the point about profit, costs and lending:

 

Property Value

$300,000

Equity

$60,000

Debt

$240,000

   

Proposed fixed price construction costs

 

2 units - complete

$500,000

   

Contracted sales prices

 

Unit 1

$450,000

Unit 2

$450,000

   

Profit

$100,000

 

The bank will see that there is a fixed price quote for construction, that there is profit in the deal, that the sales contracts have been signed, and that there is an exit and definitive plan for paying back the loan with enough money to pay the interest. In this circumstance, the experience of the applicant for the loan carries very little significance. The deal stands very strongly on its own merits.

Option 2:

  • Rent for six months, put in plans and permits and get them approved.
  • Once approved, research and select a builder to undertake and manage the construction. Get a fixed price quote for the entire completed works that fits the sale price and delivers the expected unit quality.
  • Research the values for new units in the area and the likely rate of market driven growth in the area.
  • Once the valuations have been determined, go to the bank for a construction loan.

The numbers will be the same as option 1, but the risk is greater. Without contracts in place, you’re relying on market estimates to predict sales values. If the bank is of a different opinion to you, then they will feel less certain. But even under these circumstances, the deal looks OK.

Assuming the builder is reputable, and has a history of delivering on time in full and on budget, it will be likely that the bank will put some sort of loan offer on the table. It might have a lower LVR, or a higher interest rate or both, but a loan is still likely.

Option 3:

  • Rent for six months, put in plans and permits and get them approved.
  • Once approved, estimate the cost of construction, the sale values with limited justification, and go to the bank with this information

The numbers may be the same as options 1 and 2, but they are estimates and the proposal is weak and uncertain. This will make the bank nervous.

The bank will then look hard at the applicant to determine if the risk is justified. As you have never done a development before, and the figures are loose and uncertain, you may not get the loan.

If on the other hand, you were an experienced developer with an established profitable history with the bank, this construction loan would likely be approved.

In essence, lending approvals are all about the risk to the bank and the applicant. If you were able to mitigate nearly all of the risks, and demonstrate with certainty (ignoring fire, war, earthquakes and the like) the ability to pay the money back with interest, then the loan is looking good.

In addition, it’s worth speaking to a mortgage broker for the inside running on how to get the construction component of a development deal across the line.

  • Answer provided by Brendan Kelly, RESULTS Mentoring (www.resultsmentoring.com.au)

Whether you are looking to buy your first home, move home, refinance, or invest in property, a mortgage broker can help. Access loans from all the major lenders, get help with paperwork – plus there is no charge for this service. Get help from a local mortgage broker

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