Property Development Finance in a Tough Lending Market
Property development finance is currently perceived to be very tough to get in the west Australian credit market.
Recent regulatory changes and investigation into lending practice by various regulatory bodies such as ASIC, APRA and most recently a Royal Commission into banking misconduct has certainly resulted in the perception of a more restricted lending market.
Many small-scale developers who rely on development finance from major lending institutions may have experienced the frustration of having finance inexplicably knocked back where hitherto it was approved. In fact, in most cases development finance is still very obtainable – no does not always mean no.
Often in real estate development approval of finance relies on:
- Presenting to the right lender
- How the project is presented
Presenting to the Right Lender for Property Development Finance
While in Australia there are a multitude of lenders for your scenario there may only be a short list that would finance your development. Knowing who these lenders are and their lending criteria will assist enormously in improving the chances of obtaining property development finance.
To illustrate the great variation amongst lenders with some simple examples you may be surprised to know that:
- Many lenders will consider any application for residential development loans where three or more units are proposed as a commercial loan. This will attract higher interest rates and fees etc. There are a handful of lenders who consider up to four units as a residential development loan. In this case standard rates and fees will apply to the loan. This can be an important consideration for project feasibility and cash flow ( you can learn more about feasibility studies here) .
- There are some lenders who will approve uncontrolled ‘cash out’ based off land value. What this is means is that the borrower has full control over the release of funds. This can have a positive effect on the often-critical timeline of the project by reducing project stage progress when release of capital is being held up by the lender. By comparison many lenders control the release of funds in pre-approved stages. This can frustrate timelines as an inspection by an officer of the bank may be required before funds are released. This is often subject to usual bank delays.
Returning to our previous comment that ‘no does not always mean no’ , it is worth considering that one of the marvelous things about having so many lenders in the Australian financial market is that there is almost always someone who will finance your project – albeit sometimes with more restrictive or expensive lending conditions. What is poorly understood is that getting initial finance is often the hardest part. Where an alternative lender is the only option, this does not mean that you are ‘locked into’ that lending institution. Once the project has been completed, most major lenders are happy to refinance an established development. This usually comes with a sharp drop in rates and holding costs.
An expert in the financial field will be able to help navigate you through the many options to find the right lender to provide property development finance for your project.
How the Project is Presented to Obtain Property Development Finance
How the project is presented both verbally and in the loan application documentation plays a crucial role in whether or not the loan for property development finance is approved by the lender. Just saying the wrong thing once can result in the banker running for the hills.
For example, most lenders will not approve a project that they consider to be ‘short term lending’. ‘Short term loans are commercial in nature defined as financing a project where there is a complete sale and divestment of created assets and closing down of the loan facility in a short period of time -typically one to two years (‘build and flip model’). most residential lenders are unhappy with this situation as the lender has high exposure but owing to the short time period of the loan, make little return by way of interest repayments as interest repayments generally are more substantial where loans are for a longer period (ie. 30 year mortgage). It can easily be seen how the objectives of the bank and a real estate developer seeking finance are at odds. Commercial property development finance with higher interest rates, is what is on offer from most major lenders in Australia for these sorts of projects where the intent is to sell in the short term.
By comparison, were the same request for property development finance is presented as a build and hold strategy (with a longer repayment period) the bank would have a greater appetite for the project. There is no reason that a borrower who has financed a loan based on a build and hold strategy cannot sell their assets and close out the property development loan as and when a change of circumstance requires- there is also significant benefit from a capital gains tax, capital growth and passive income perspective to warrant considering a hold.
Alternative sources of finance
Acquiring property development finance is not limited to traditional lending. Many projects are financed using alternative means and strategies, which can be much more flexible and are possible so long as all parties benefit.
Alternative methods of finance include:
- Joint Venture; two or more persons (natural or corporate) undertake to own and run a single project jointly and contribute funds, land or equity to the project. Importantly, where any finance is sought to fund the project lenders will normally assess the liabilities of all partners in the joint venture collectively. It is important to know who you are joint venturing with as cross collateralisation of their own debts may jeopardise your own borrowing capacity. Conversely, their borrowing capacity may enhance your own.
- Syndicates; Similar to a joint venture, varying in that the syndicate may not wind up at the end of the project. The syndicate members are unit holders in a trust and/or private company and may run more than one project at once. Profits may be reinvested in the syndicate perpetually until such as time as syndicate members vote to wind up the syndicate. The collective assets of the syndicate can mean larger projects can be undertaken potentially with higher returns than if any one member of the syndicate chose to peruse a development on their own. In some syndicate’s members can sell their shares to other members. New members can also be invited. Syndicates can also be a useful way to reduce the individual members’ risk as the risks of the project are shared out amongst the shareholders of the syndicate. Greater expertise can be brought to a project where a syndicate includes a number of experienced developers who bring their knowledge and networks with them.
- Private lenders – private lenders, who will assess a project on its merits upon receipt of an information memorandum or a business case may undertake to fund a part or the whole of the development in a return for a share in profits or a set fee.
Non-Conforming Lenders; some lenders are not restricted by lending practice charters or regulations which major lenders are for various reasons. These are called ‘non-conforming lenders’. Whilst these lenders may charge a higher interest rate, this can still be a viable way to fund a project where the project is lucrative and unable to attract interest or endorsement from larger lenders who may be constrained by stricter lending policy guidelines.
- Development leases; a development lease works best where a land owner has an unencumbered block of land but no cash to finance the development and no borrowing capacity. The developer is permitted by the land owner to place a mortgage over the property (sometimes a second mortgage) which the developer personally guarantees. The developer undertakes to develop the land. The land owner and the developer split the profits according to a pre-determined scale. This can be in cash, units etc. There is no transfer of land between the developer and the owner so no stamp duty. The land owner will generally have a greater capital realisation of their asset than if they sold it ‘as is’.
- Equity partnership; in an equity partnership arrangement, a supplier working on the project may agree to fund a part of the project with their own equity – either in labour capital or as a shareholder in the project. The supplier would agree to provide either cash or equity through mortgage guarantee. A share in the profits of the project or an escalated return on usual fees may be the consideration paid to the supplier in return for contributed capital to the project. For example, an earthworks contractor may be considering a project with a $250,000 earthworks component. They may agree to undertake the work for $120,00 upfront payment with a $150,000 ($130000 balance + $20,000 bonus) payment upon sale of the assets.
As well as reducing the required amount of input capital this can be an innovative way of incentivising suppliers to work harder and achieve the best outcomes for the project as they have ‘skin in the game’. This personalised interest can be a factor wholly absent in scenarios where the contractor or supplier has been paid in full and has no ongoing interest.
Property development finance is just one part of the equation that is affected by your trading intention. Taxation is the other. Whether you are trading, or holding, will also effect your tax strategy. Further, if a developer plans to make a profit (which they should all be doing!) consideration should be given to how the profits will be distributed. Often distribution of profits needs to be optimised by a tax agent who can substantially reduce the personal tax liability of the individual by using a structure involving trusts and corporate entities. Importantly, the structures used for tax planning will normally have to be in place before a project is acquired (land purchased). The structure may also change which lenders are willing to provide finance to the project.
Taxation is an important consideration when getting involved in real estate development. It is highly advised to include a qualified tax professional in development planning from the start of the project.
No money. No project.
Where your property development finance is coming from is a crucial part of project planning. Put simply – no money, no project. There are many different options to explore; knowing who to talk to and how to present a project correctly is vital. As was emphasised at the beginning of this article ‘no does not always mean no’, its often the way a project is presented. FLYNN can help to find a financial solution which will deliver your project. We invite you to use our expert network of brokers and finance consultants to help navigate and find the right finance solution for you.