Residential Property Development Finance – 5 Tips That Will Have You Ready to Apply
If you’re interested in property development, you need to learn about residential property development finance.
This is because unless you have significant working capital, you’ll need a lender to bankroll your project.
We’ve been in this space for a while, and someone can rarely fund a development upfront without relying on finance.
If you are considering a residential development project, one of the very first steps is to get a clear understanding of both your borrowing capacity and your serviceability.
This information will help you figure out the type and size of the project you are looking to undertake.
In this article, I’m going to discuss five tips that will get you ready for the application stage of residential property development finance.
1. Understand Your Borrowing Capacity
You first need to assess precisely how much you can borrow.
This is important because there’s no point planning a project that is bigger than you can afford to finance.
Your borrowing capacity will depend on your project plan and feasibilities, as well as the standard assessment criteria for finance.
For instance, the lender will want to know that you are already in a relatively stable financial position.
They may also want to see that you have prior development experience and that you have an airtight development plan.
If you don’t have these last two things, you may want to consider a joint venture with a business partner who has this required experience.
This is part of what we do at Little Fish.
Like a standard loan, you’ll probably need to give the lender your last two payslips as proof of income, as well as bank statements and ATO payment summaries from your employment.
2. Clear Your Credit File
Any loan of money requires a credit check.
Most mainstream lenders will not approve a loan if you either have any amount of defaults on your credit file or a large number of enquiries in a short amount of time.
If you have a patchy credit file, we strongly recommend you tidy it up before applying for residential property development finance.
You can do this yourself for free – avoid those expensive credit repair agencies.
There is a wealth of information online about how to tidy up your credit file, and have defaults removed.
Enquiries generally can’t be removed though, so if you’ve just applied for multiple lines of credit and have been knocked back.
It may be wise to wait a few years before trying to secure finance for your project.
Some lenders will loan you money if you have a patchy or flat out bad credit score. But be warned, you will pay a much higher interest rate than usual.
The interest paid on property development loans can sting, and you need to have enough liquid capital to afford principal and interest repayments until your properties sell and you can pay out the loan.
3. Assess Your Survivability
By survivability, we mean having a financial buffer in place should the project blow out and cost more.
This can happen all too often for various reasons.
Disputes between the builder and their subcontractors can delay a project, as can union involvement and other factors.
You might also wind up in a dispute with your subdivision builder.
A lender needs to see that you have some contingencies in the form of a cash buffer in case of project delays or blowouts.
If you can’t survive an alteration to your project’s timeline, you may need to rethink your choice of investment until you’re in a better position.
4. You’ll Need Security for Your Loan
Most lenders will offer what is called secured finance, whereby the bank wants an asset put up as security, in case the project fails.
In some cases, this might be the equity in existing real estate, such as your principal place of residence.
So, when preparing to secure residential property development finance, you need to be prepared to put up an asset as security for the loan.
5. You’ll Need a Feasibility Study Prepared
Another tip for preparing to apply for residential property development finance is a well-researched and put together feasibility study. This is evidence that you have considered all outcomes and angles.
The lender needs to be confident that you have correctly calculated the cost of construction compared to your potential return on investment.
This is your profit margin, in other words.
Without airtight evidence of a decent profit margin, the bank will think twice about lending to you. At the end of the day, they want the profit from the interest you’ll pay as well as their principal returned to them.
Your feasibility study needs to include accurate estimates of the following costs:
- Applications for development/permits – these can change depending on the local government
- Building expenses – this includes all hard costs, like wholesale materials, builders fees, contractor costs, upgrades and variations
- Sales costs – such as stamp duty, sales agent fees and conveyancing costs
- What is known as overruns – blowouts in costs. Remember our tip about a buffer above. Banks will want evidence of your buffer.
The bank wants to see around a 20-35% profit margin in your feasibility study. Or else you might struggle to get your finance approved.
There are some extra things you’ll want to include in your study, such as:
- The experience and certifications of your builder
- Site details, such as location and zoning
- A design concept or the render of the dwellings
- Other costs, like soft costs (you’ll need to pay for these yourself though)
- A construction timeline
- Your plans to sell either off the plan or if you have tenants waiting.
If you have airtight feasibilities, you should breeze through the loan application process.
Remember, in this game knowledge is power, but it’s also money. So do as much research as you need to arm yourself with the ability to get ahead.
I’ve shared five tips to get ready to apply for residential property development finance here. This is by no means an exhaustive list, so be sure to check out our finance blog category.
This is to get a better sense of everything to do with property development finance.
If you’d like to know more about property development or are considering trying it out as an investment opportunity, contact the friendly team at Little Fish today.