Something I get asked on the daily is how much money do I need to start a property development.
It’s a great question but the answer can be complex. For the purpose of this article, I’m going to simplify and generalise it the best I can.
I want to get you thinking the right way about it and heading in the right direction.
Alrighty. Let’s talk about money. In particular, let’s talk about how much you need to get your first townhouse development project off the ground.
The Quick Answer
The short answer. The more money, or capital you have to contribute to your project the better.
The more money or capital you put into a project is going to mean less risk. And of course, the less interest you’ll need to pay given less funding will be required.
How aggressive is going depend on your loan structure and your own personal and project circumstances.
The caveat though is that your capital will be tied up for the duration it is required for the project. So, you won’t be able to use it to invest elsewhere or to enjoy your life.
It’ll be off working for you!
Everyone will have different motivations when it comes to their project and will want to leverage a funding strategy that makes sense to them.
What makes sense for you and your project may not make the same sense for someone else and their project.
The key is to understand your options as clearly as possible so you can make the best-educated decision for yourself and your project.
Your decision needs to be based on your own financial position and personal circumstances.
The Moment of Truth
How much you will need to do a property development is going to come down to the project type and the project size.
As a general rule, you want to have somewhere between 25-35% of the proposed overall development cost.
It will come down to your lender’s appetite for the type of project you are looking to do.
All funders have different lending appetites and criteria.
It is essential that you get good advice. You need to partner with a broker that has significant experience in the type of development you are looking to do.
If it is a Melbourne duplex, then ideally you need a broker that has experience in that area.
It sounds obvious. But just because a broker tells you they have experience in this type of funding, it doesn’t mean that they do.
So, you need to be careful and make certain you are getting good quality advice.
Loan to Value Ratio (LVR)
A key term and calculation you will need to become familiar with is Loan to Value Ratio. Also known as LVR for short.
LVR is one of the key factors that banks use to determine the amount of funds that they will be prepared to lend you for your project.
The Loan to Value ratio (LVR) is the amount of your loan compared to the value of your property. LVR is calculated by dividing the amount of the loan by the value of the property.
For example, if the property is worth $250,000 and you have a deposit of $50,000, the LVR will be 80%.
Let’s say …
You purchase for 1 million, the plan is to build for 800k with an additional 100k in development costs.
That’s a total project cost of 1.9.
In this case, as a minimum, you would require 25% of that figure so approx. 475k
It is important to note that you don’t need to have the cash upfront.
Typically, you would use other assets that have equity in them that you can draw on such as your house of residence.
This is a common way of funding the capital portion of townhouse development projects.
Gross Realisation Value (GRV)
Another key term and calculation that you need to understand is Gross Realisation Value. Also known as GRV.
GRV is another calculation that lenders use to determine what they are comfortable funding for a project.
For example, let’s say you have just received Town Planning approval for your project.
You have completed your working documentation, run your tender process and have signed a construction contract with your selected builder, and you are ready to apply for your construction funding.
The bank will look at your projects Gross Realised Value to determine your Loan to Value Ratio.
Essentially, they look at what the end value of your project is (so total sales) and they work backwards from there.
A key point here is that achieving town planning approval for your site will by default increase the value of the site.
Hence this is the time to go to the bank to apply for your construction funding as it will position you to borrow the maximum amount.
It’s important to note that the lower LVR you have the less risky your project is as your lender will have less control over your project.
When you are looking at a project and trying to understand your own financial capabilities it is critical that you are not operating too close to the line financially.
You need to ensure that if you start your project that you will have the financial capabilities to get it to the end.
Not getting your project to the end is the biggest risk you will face.
So, avoid working with rubbery numbers. Stay as far away from the line as practically possible.
Do not over capitalise and take unnecessary risks.
Remember murphy’s law, if it can happen it will happen. This doesn’t mean something bad is guaranteed to happen.
It means if you take unnecessary risks and you are exposing yourself to the potential of something going wrong then in all likelihood it will.
In closing, if your site makes sense to develop and the numbers stack up you will be able to get funding.
There are countless funding structures for all different circumstances and scenarios and property development tax deductions you’ll need to get your head around.
The key is to tap into the right expert advice.