What is Property Development Finance?
Unless you can afford to pay for your development with cash. You’ve usually got to rely on a form of credit which you then pay off over time.
Millions of Australians borrow money every day. A basic example is using a credit card to cover an expense you don’t have the funds on hand to pay for right away.
Another is financing the purchase of a new or used car to get around. A home loan with a mortgage is another example so you’ve got somewhere to live.
Finance is a part of life. Yet more and more regular people want to generate wealth.
At Little Fish we’re in the business of helping them do exactly that. We assist everyday people all over Melbourne to either develop their existing land or to acquire a prime site to develop and get it pumping with multiple dwellings which we then help them to sell.
The majority of our clients need to acquire some form of finance to make this happen.
We often get asked, “what is property development finance?” So we thought we’d put together this helpful article to explain the ins and outs of borrowing, lenders and all things related to this commonly asked question!
Some Basic Definitions
Property development finance is a loan that is designed to fund the construction of multiple dwellings on one lot of land. This could be a simple side by side dual occupancy design in Melbourne which is a residential property development loan, all the way up to a mixed-use commercial and residential skyscraper.
Side note: not sure what a dual occupancy is? click here to learn more.
For this you’d want a commercial property development loan. For the purposes of this article we’ll be focusing on the residential finance angle.
It’s worth mentioning that a small residential development, where you build two or more townhomes on a suitable block, is a great, low-risk and high-return way to generate some passive income and build your wealth.
The Different Stages of a Property Development Loan
Unlike a loan for an owner-occupier property or even an investment property, residential property development loans are structured differently. Essentially, rather than being released to the vendor upon settlement, funds are released at different stages as your project kicks along.
The stages are usually like this: the deposit, the base stage, frame stage, lock-up stage and fixing stage. Don’t worry too much about what these stages mean. The basic premise is that the lender will release funds along the way.
This way you can keep paying your builder so they can keep working on your project. And you only pay interest repayments on the money you have drawn down.
Any balance of your loan remaining at the end of the build is released to you at the end of the project. If the builder is paid off, you could pay this back to the lender to reduce your principal and interest.
Some Features of Property Development Loans
Usually, you can borrow up to 80% of the cost of the project. This is called loan to value ratio or LVR. For example, a project worth $2 million will require a $400, 000 deposit. Most people we work with will use the equity in their homes or land to come up with this capital.
A property development loan will generally have a higher interest rate than a personal or investment property mortgage. It’s not necessarily a significant amount.
Usually 1-2%, but because we’re usually dealing with larger principals this can add up so you need to always have a buffer in case your project is delayed so you can afford to keep paying the interest.
Speaking of buffers, some lenders (although not all) will need you to have some contingency funds in place in case something delays the project. Builds can be delayed for various reasons most if not all will be out of your control.
If a lender requires you to have a contingency, it’s usually 10-20% of the loan amount so you can cover any shortfalls due to delays but this is more often in larger scale developments and is less common in the small to medium development space that we here at Little Fish operate in.
Finally, property development finance usually covers “hard costs only”, which is labour, materials and other construction costs. This means that “soft” costs, like planning approval fees, land clearing, conveyancing and architect designs aren’t covered so you need to be able to pay for these upfront.
Things to Keep in Mind
There are a few factors that you’ll want to consider when getting ready to apply for property development finance.
- Know exactly how much you can borrow first and foremost. Approach lenders or brokers and get them to provide some estimates so you know how much they’ll lend you. You can then balance this against the “soft” costs mentioned above. The project needs to be viable for you to generate wealth from it.
- Have a clear strategy. Know exactly why you’re developing your land. Do you want to sell all the properties of the plan before settlement? Is your motivation to live in one, sell one, and retain one as an investment? Are you looking to rent them all out? This will factor into your decision and give you some estimates of passive income and potential profit.
- Property development loan applications are quite complex compared to other home loans, so allow plenty of time and be prepared to jump through as many hoops as the lender deems necessary before agreeing to finance your project.
Consider Approaching a Broker
If this is a daunting topic and you don’t have the time or energy to do all the work yourself, consider enlisting a professional loan broker. A broker is a professional whose job it is to find their customers a great deal on a finance product. They get paid a commission by the lender for finding them a customer.
There are a few specialised development loan brokers in Melbourne, a quick Google search will find them for you. Or, if you’re taking an armchair developer approach (which is fine!) then ask your trusted property development consultants to take care of approaching lenders or brokers for you.
There you have it, hopefully that clears up what property development finance is.
Want to Embark on Your Wealth Creation Journey?
If you’re keen to learn more about becoming a property developer, or want to know more about finance, Little First Property Developments are ready to help. Call 1300 799 277 for a free, no-obligation chat, we’d love to hear from you!