Construction Loans vs Residential Loans

[bumblegoodie]

Sorry guys another dummy questions for the experienced developers

had my PPOR renovated, revalued and re-financed.

Now we have approx. $250K of equity in our offset account to play with.

Not sure if it is sufficient amount to buy a develop-able land and construct a duplex development.

What i dont understand is how much cash do you need in hand and additionally with the equity in the PPOR to start a duplex development?

I have no idea the differences between a resi vs construction loan????


anyone can give me a head start?

 

[A Jeremy]

Depending on your lender a residential loan may be for an established residence while a construction loan is to build a small number of residential buildings. I think it's up to four and after that it has to go onto a business loan as required by the National Consumer Credit Protection Act 2009. I could be wrong.

You can negotiate anything so after construction is complete you can go back to the lender and ask for the residences that have now been completed to be put onto a residential loan.

On the other hand a construction loan can be either a residential loan or a business loan. There is threshold which I believe is around the $2mil dollar mark where if an entity or people in control of an entity have that much in loans then the application must be for a business loan. It seems I'm a little rusty on the things my bank manager told me last year but these aren't hard questions for your lender or someone on here, who is more informed than me, to answer.

 

[Jamie M]

I have no idea the differences between a resi vs construction loan????

Hiya

I think you're getting confused between resi and commercial loans.

Any type of small development is going to involve construction finance - the size of the development will dictate whether it be under resi or commercial terms.

Cheers

Jamie

 

[bumblegoodie]

Thanks Jamie.

Could you please elaborate a little more on this?

my current situation is refinanced with cash of approx. $200K in the offset account.


I would like to find a land around $800K and construct of a duplex around $700K. Total $1.5 million.

So how do i do this? how to structure this? where to go from this?

confused with the finance side.

 

[euro73]

In pretty basic /general terms, if you have 200K cash available and want to purchase land for 800K and construct dwellings worth 700K for an end debt of $1.5 Million , you need ;

90% loan + LMI , secured against the land you purchase for 800K. ie - a loan of 720K , requiring you to contribute 80K deposit + stamp duty of $31.5K ( assuming NSW is where you purchase) - so you'd contribute / use @ 111.5K of your 200K cash

90% loan + LMI for construction of 700K dwelling/s , based on a fixed price building contract . So you'd be contributing @ 70K of your 200K cash.

This would require @ 181.5K of your cash. Of course, you'll have small number of other miscellaneous loan costs and solicitor /conveyancer fees, so round it up to $185K

because you have @ 15K "spare" , you may be able to get away with doing one of the loans ( the land loan or the construction loan) at 90% inclusive of LMI rather than 90% + LMI - or close to it .

 

[Shahin_Afarin]

With a duplex development the valuer will valuer the development in one line which means you need to (as a guide) shave 15-20% of the end value.

Most banks will lend on the lower of the valuation or land plus construction costs.

So make sure you have adequate cash to cover this.

 

[Peter_Tersteeg]

A construction loan is usually a residential loan for construction purposes. It has a few extra features but it is still a residential loan for a duplex.

Any sort of development of residential property up to 4 units would probably be done as a residential construction loan. There's no real advantage doing it as a commercial loan. In most cases it would actually be harder to qualify for a commercial loan and it's certainly going to cost more.

Hence the comment that a duplex development would be done as a residential loan.

euro73 has broken down the numbers for how much funds you'll need to contribute to deposits and purchase costs. What often gets forgotten though is now much it costs to get plans drawn up, approved and to a stage to where you're ready to build. This needs to be paid for by cash and it can cost a significant amount ($30k+ would not be unexpected).

A quick look at the numbers suggests there may not be much profit in the deal, it's very hard to say. Make sure you go through your costs to build and ensure there is a healthy profit margin before proceeding with this type of deal.

 

[bumblegoodie]

thank you guys.

This really clear up my understanding.

Euro, awesome explanation and pretty much directly explained my question.

Shanin, thank mate for the guidance

Peter, excellent answer, understood.

One more confirmation, when you guys say cash does it mean equity cash (due to re-finance in offset account) or cash sitting in the bank account (not borrowed)?

 

[bumblegoodie]

Euro,

btw how are you doing with NRAS property investments?

I thought reading something about the government scrapping NRAS

BG

 

[euro73]

Govt scrapped Round 5 only - that was the final 10,000 allocations that were planned for the scheme. But the balance ie the other 40,000 ( Rounds 1,2,3 and 4) were not scrapped and have in fact retained FULL funding support, with funding in place in the forward estimates through to 2027. All remaining allocations ( there are approx 18,000 of the 40,000 yet to be delivered) must be delivered by June 30,2016.

To answer your question - it's going extremely well. On a personal level I have accumulated NRAS properties in locations such as Bendigo, Ballarat, Dubbo, Orange, Port Macquarie x 2, Elanora Heights, Castle Hill, Windsor ( QLD) Alderley ( QLD) and others I'm having a goldfish memory lapse on, and plan to purchase several more this year - which will give me a portfolio valued at well over $5million ( I also have a couple of non NRAS) which is completely CF+ /self sufficient for the next 10 years. I have also used the surplus Cash Flow to pay off my PPOR mortgage of 440K in the last 2 years, so all things considered I have put my money precisely where my mouth is and achieved great results using the NRAS "system" I so often talk about on here. I have geared the majority of the INV portfolio to 90% or more, but between the non NRAS properties I have owned for a decade or more, and an unencumbered PPOR I have an overall LVR of @ 70% now , and am paying zero personal income tax

On a business level I sold @ 180 NRAS properties in 2014, had no valuation issues at all and have set those investors on a path to accelerated payment of their non deductible debt , with the multiplier effects that will create in coming years - many Somersofters were amongst those buyers.

Launching what will be the last batch of NRAS in the next few weeks, in locations such as Goulburn (which Terry Ryder seems to think is one of the top 2015 hotspots) some more Port Macquarie stock ( which he also recommends as a hotspot) some beautiful apartments in Canterbury, some 2 Bed Penrith Apartments inside the Thornton Estate opposite Penrith Station, and some 3 bed townhouses inside the Bunya Estate in Bungarribee - or Doonside/Eastern Creek if you prefer There are a few other bits n bobs in the works as well...

My view about NRAS has always been - it doesnt need to be all of your portfolio, but for most investors , especially those with relatively large PPOR debt and a relatively immature investment portfolio, it's critical to pay off a PPOR mortgage and add extra cash flow to a portfolio if you really want to get ahead of the curve and grow it beyond the 2-3 propeties where most people stop. NRAS does that in spades, so it should form some of a portfolio.

Because if capital growth alone is such a magic wand, why is it that the majority of investors fail to get beyond 2 or 3 properties? Even during the greatest credit boom and property boom in our history (the last 20-25 years specifically) most investors stop at 2 or 3. We know this to be true because ATO data tells us so. The answer of course, is cash flow, which only goes to prove that all the equity in the world is useless when you have no more borrowing capacity - just like all the cash flow in the world is useless without equity for deposits, as I have said on many previous posts. The pursuit of growth at the exclusion of cash flow results in a choice for most mere mortals between having to sell and pay CGT, or running out of puff. Well I choose neither. I choose a portfolio that allows me to run CF+ and pay off debt aggressively as I go, so I don't ever have to sell /pay CGT just to make another purchase. I choose a portfolio with sufficient cash flow to provide me with time in the market, rather than guessing at timing the market.

I believe PPOR debt reduction is critical for those mere mortals who dont enjoy high incomes; getting rid of non deductible debt is the key to unlocking borrowing capacity so you can actually continue to take advantage of equity as it is created in future.

And if Im wrong? well, Ive already paid off my PPOR in full using this strategy and my portfolio costs me nothing to hold - so if I lost my income tomorrow I am still able to hold. How wrong can I be?

 

[bumblegoodie]

thanks Euro and well done mate.

So are there any negatives to have NRAS properties?

Could you point those out?

How much debt did you reduced when owning 2 years of NRAS properties ?

 

[euro73]

There are potential negatives to every investment. GFC2 could come knocking tomorrow. APRA and the RBA and the Govt may revoke or change or fidle with neg gearing... we can all spend our lives worrying about what if's, or we can assess the numbers and make decisions.

NRAS provides a number of mitigants - It reduces the probability of vacancy because you have a 20% advantage. It allows you to discount further if for some unforseen reason the rental market collapses. You can afford a reduction and still remain CF+ - can the next door neighbour without NRAS say the same? But most importantly it allows you to hold properties even where you have a period of unemployment. It is essentially as safe as property investment can be, without committing to some form of head lease.

The biggest issues are finding good deals that value up. Far too many NRAS properties have been sold through project marketers who inflate the prices. There's essentially nothing wrong with the properties in most instances, but plenty wrong with their price tags. To be fair, this happened long before NRAS and will continue happening long after NRAS. It actually has nothing to do with NRAS at all, and everything to do with the models and tactics those companies utilise, but critics like to use guilt by association as an easy way to hang a scare campaign around its neck.

My PPOR debt was @ 440K 2 years ago, but you should understand that I had both the income and the appropriate number of properties to take maximum advantage of NRAS in order to get that result. I am not suggesting everyone can replicate what I have done - but certainly anyone can achieve a healthy reduction in their taxable income and a healthy increase in their after tax income with just 1 NRAS property. Obviously the more properties and the higher the income, the bigger the benefit, but you can really only worry about squeezing all the juice out of your particular lemon. I have clients ( including several Somersofters) who have had sufficient equity and borrowing capacity to purchase just 1 NRAS, and others who have been able to purchase 3, 4 or 5. Each of them will achieve different degrees of PPOR debt reduction - but each of them has squeezed all the available juice out of their particular lemon. Importantly, each of them will be in a dramatically stronger position in 10 years than if they'd done nothing

 

[bumblegoodie]

thanks for the insight to NRAS.

May worth the time to speak to you directly.

 

[Redom]

thanks for the insight to NRAS.

May worth the time to speak to you directly.

Definitely recommend giving him a call - euro73 has helped me grow my own little portfolio over the past 18 months and has educated me on the nuances of NRAS for hours. Knows his stuff better than any operator I've come across - by a long way.

His strategy has worked pretty well for him and when utilised correctly, is very powerful at achieving certain goals. It wont get you there 'quickly' like the manufacturing growth plays, but as an income stream, its pretty powerful and potent to going far.

Cheers,
Redom