9 Mistakes to Avoid When Borrowing for Property Development
The reason people borrow for property development is that it is quite rare to have enough working capital to fund a residential development project right off the bat.
Some people do, but they’re usually already wealthy as punch, and it becomes more of a hobby for them.
If you can finance a whole development without borrowing, you might not even need the profit.
For people, we work with, and regular Aussies, most of them are going to need to borrow money to get their project off the ground.
We’ve covered some general information about property development finance in the past.
In this blog post, we’re going to discuss nine mistakes to avoid when borrowing for property development. Have a read through, and you’ll emerge at the end a bit wiser.
Remember, in this game knowledge is power, but it’s also money.
1. Only Approaching a Traditional Lender
Some people get locked into the thinking that a bank is the only source of finance out there.
Sure, they’re the most common way to access capital, but they’re not the only way.
If you haven’t already read through the article linked above, which discusses the differences between traditional and non-traditional lenders.
2. No Contingencies or Back-Up Plans
Any financial investment should involve a degree of planning.
This planning needs to include a thorough risk assessment and subsequent contingencies. Remember Murphy’s Law – if it can go wrong, it will go wrong.
You need to have a plan B, and then a C and a D for when (not if) things go off the rails.
3. Avoiding Expert Advice
In this game, unless you are at the absolute peak of your knowledge, you need to rely on the experts.
You should seek professional financial and legal advice before embarking on any significant investment, including property development. Pride comes before a fall, and in this space falls hurt hard.
But be wary here, especially when it comes to finance brokers. This leads us well into our next point.
4. Picking the Wrong Broker and Financial Advisor
Not all brokers are equal. Some specialise in owner-occupier loans, while others still specialise in investment loans (for rental properties).
You need to ensure that you’re working with a broker that has substantial experience in residential development.
If you pick the wrong broker, you could wind up making significant decisions based on weak or flat out incorrect advice.
Brokers want your business. If you approach one that might not have the experience you need, they are unlikely to admit it, as they want your business.
Development finance has countless variables, options, structures and moving parts. You need a broker who understands your situation perfectly and can advise you accordingly.
The same applies to a financial advisor or planner. Make sure you pick one who is ideally suited to your needs.
They are a dime a dozen but a great one is worth their weight in gold. Ask around your networks and rely on reviews and testimonials.
5. Not Knowing the Details of Your Loan
You need to read all the fine print and be aware of every single condition the bank places upon your finance.
One thing we’ve seen bite people on the behind is getting locked into loans that come with substantial early paydown fees.
This means if you pay your loan down before the signed term, the lender slugs you with a considerable fee.
It is critical that you can pay the loan down on project completion and once the sales settle. This is so you don’t pay out the you-know-what in interest.
This sounds simple, but you’d be blown away how often people get caught out with things like this.
Also, different sizes and types of developments will have varying funding requirements. A bank views a duplex and side by side dual occupancy designs differently to a three-dwelling corner site.
You need to be aware that if you’ve obtained finance for a past project, you aren’t guaranteed the same structure or type of funding for your next one.
6. Not Factoring Soft Costs In
A lender will usually only lend on things like the purchase of a site and the construction costs.
7. Being Too Stubborn on Your Choice of Loan
We often see people get obsessed with getting a fixed-rate loan at a lower interest rate.
This is a mistake. Fixed-rate loans have those huge payout fees we mentioned above. And in property development, you want to settle and pay off your finance once you have your profit.
For this reason, the variable rate is always better.
A variable rate loan offers flexibility and the ability to pay it down sooner, which is what you want when borrowing for property development.
Besides, interest rates are at record lows at the moment, so there’s no valid reason to opt for a fixed rate and get locked in.
8. Underestimating Development and Construction Costs
We see this happen a bit, particularly with inexperienced developers who get excited and let their emotions run the show.
Although we’ve said this before, we’ll repeat it. You need to keep a cool head in this game. You cannot afford to let your emotions run the show. Cool, calm and collected is the name of the game.
When people run on emotion, they take risks and make mistakes. A significant error is underestimating the cost of construction in their feasibilities.
This can result in a massive shock once the design and documentation are done and dusted. The tenders arrive from the builders and boom – the building costs exceed the budget.
A lender will see this and judge you harshly.
You need to ensure your initial feasibility is a realistic representation of the costs associated with the project and is as accurate as you can get it.
Double, triple and quadruple check your figures here. This is a mistake you cannot afford (literally) to make.
9. Using Funds Earmarked for Development for Another Project
Developing real estate is like being an entrepreneur. You’ll always be on the lookout for future opportunities.
Sales agents will get to know you, and you’ll begin to get access to off-market properties at below market value rates.
We see people use funds from one project to bankroll another, in the hope that the profits from one will pay for the other.
This is a surefire way to wind up in financial strife. Remember Murphy’s Law. Delays and disputes occur and blow out a project.
The way to avoid this mistake is not to commit funds until they are realised. Once your properties settle and the money is in the bank, and the finance is paid off, you can then look at a new project, no sooner.
A final tip – each project needs to stand on its own merit. Don’t rely on finance from your other projects as you can knock your cash flow and profits for six.
Assess each new opportunity on its own merits and assume a separate budget and finance structure for each new project.
And remember your contingency plans.
Here’s a great list of mistakes to avoid when borrowing for property development – nine of them in fact.
Development finance is an important part of a development project so make sure that you get it right. This is not something you can afford to fix after the fact
To learn more give the friendly team at Little Fish a call on 1300 799 277 for a chat.
Plug your project directly into our development management services. We’re always happy to share our knowledge if you have any questions.