Full Development Finance if GRV under 70%?

[Land]

Quick question regarding development finance.

My wife and I are currently doing a dual occupancy development based on standard residential lending. We intend to do two more after this, moving into lo-doc territory. We will retain all of these as investment properties.

However, after that, we are hoping to do some development as a business. My understanding is that you can usually get a commercial loan of 70% against the gross realisation value.

Does this mean that if we were to find a DA approved site (as opposed to a site which needs us to go through the entire DA process), get fixed price estimate for construction, and provided these are less than 70% (as documented in a detailed feasability study) we can potentially obtain lending for everything?

For example:

Property purchase price (with approved DA) $1,500,000
Fixed Price Building Estimate $2,500,000
12 months interest $400,000
Sworn valuation GRV $6,500,000
Therefore GRV as % of costs = 67%

In this scenario, provided we can demonstrate our experience with development, is it possible that we could obtain 100% finance of costs?

I understand that this wouldn't be the case if we were buying a non-DA approved site, because there's no certainty about what we would get development approval for, but in the case of buying a DA approved site, everything else is able to be calculated.

 

[Qlds007]

Hi Land

Yes all things being equal and subject to the Banks valuation, QS report and the usual you would be able to obtain 67% of GR value.

I think the highest we have done recently is 77% however these were experienced developers with some good pre-sales.

This is not normally a requirement however.

 

[APerry]

Hi Land,

If you are going to do this as a business you will have to move over to commercial finance because if you use lo docs the mortgage insurers will knock you back as soon as they realise what you are doing. They have zero interest in insuring loans for developers.

Most commercial lenders fund on the lower of X% of costs and X% of end value. Most of the time you are constrained by the % of costs, usually 80%. They will also require your contribution upfront and fund the rest.

I hope this helps.

Regards
Alistair

 

[stumunro]

Hi Land,


Most commercial lenders fund on the lower of X% of costs and X% of end value. Most of the time you are constrained by the % of costs, usually 80%. They will also require your contribution upfront and fund the rest.

Sorry, my simple brain is having trouble getting head around this.

Is there an easier way to reword this hehe?

 

[Land]

Thanks Alistair - yes, the intention was to move into commercial lending as distinctly seperate from our personal investments.

I think Richard has confirmed what I was hoping.

If we were to buy a site with no DA approved, we would have to put our own money in to buy the site in the first place, obtain development consent, and then try and obtain finance for the construction cost based on the end value.

HOWEVER, if we wanted to buy a site which ALREADY had DA approval, then everything can be worked out, and provided it can be demonstrated that 100% of land purchase and construction costs is less than 70% of the end value, it should be possible to obtain 100% finance for the entire project.

I don't know if it is possible to go past 70% by levering off the builder's experience and previous projects, as well as our own growing experience?

 

[APerry]

Hi Stumunro,

Most lenders and all the major banks assess the amount they will fund on a commercial development by taking the lower figure of a set percentage of costs and end value.

e.g.

Property purchase price (with approved DA) $1,500,000
Fixed Price Building Estimate $2,500,000
12 months interest $400,000
Sworn valuation GRV $6,500,000

Total Costs: $1,500,000 + $2,500,000 + $400,000 (Assuming you want to capitalise interest) = $4.4 million.

Each lender uses different percentages but we will say ABC Bank will fund the lower of 80% of costs and 70% of end value.

80% of costs equals $3.52 million while 70% of end valuation = $4.55 million. In this case you will struggle to lend more than $3.52 million

Regards
Alistair

 

[Land]

Really?

Thanks Alistair for the feedback. At first that seems to make sense, but then I ran some figures and I'm a bit confused.

SCENARIO A - 80% of building cost more than 70% of GRV

If the building costs in the example were $4,200,000, instead of $2,500,000, then the example would look like this:

Property purchase price (with approved DA) $1,500,000
Fixed Price Building Estimate $3,800,000
12 months interest $530,000
Sworn valuation GRV $6,500,000

Total Costs: $1,500,000 + $3,800,000 + $530,000 (Assuming capitalising interest) = $5.83 million.

In this instance, 80% of costs is $4.6M, whereas 70% of end value is $4.55M, so you would be lent on the 70% of end value instead as it is lower.

The problem is, the only time the scenario occurs when 70% of end value is less than 80% of costs, the profit margin is way too slim!!

Does this mean that they will basically only lend on 80% of costs?

I fail to see why they wouldn't lend 70% of end value, and if this covers all costs, where is the risk to the lender?

SCENARIO B - 80% of building cost is less than 70% of GRV

To exagerate in the other direction, what if your construction cost was only $500,000, then it would look like this:

Property purchase price (with approved DA) $1,500,000
Fixed Price Building Estimate $500,000
12 months interest $200,000
Sworn valuation GRV $6,500,000

Total Costs: $1,500,000 + $500,000 + $200,000 (Assuming capitalising interest) = $2.2 million.

In this instance, 80% of costs is $1.76M, whereas 70% of end value is $4.55M. So if you would only be lent on the lesser amount ($1.76M), the lender would only be giving you 27%(!!!) of end value ($6.5M) instead as it is lower.

This seems extremely unreasonable, given the incredibly low risk to the lender, but it fits the model that you've proposed - am I missing something?

 

[stumunro]

Hi Stumunro,

Most lenders and all the major banks assess the amount they will fund on a commercial development by taking the lower figure of a set percentage of costs and end value.

e.g.

Property purchase price (with approved DA) $1,500,000
Fixed Price Building Estimate $2,500,000
12 months interest $400,000
Sworn valuation GRV $6,500,000

Total Costs: $1,500,000 + $2,500,000 + $400,000 (Assuming you want to capitalise interest) = $4.4 million.

Each lender uses different percentages but we will say ABC Bank will fund the lower of 80% of costs and 70% of end value.

80% of costs equals $3.52 million while 70% of end valuation = $4.55 million. In this case you will struggle to lend more than $3.52 million

Regards
Alistair

sorry for hijack land !! last q's i promise //

so in this instance you would need 880k up front for the difference in development costs.

Will they let you include purchasing costs, deposits, solicitors fees etc in to the costs or is it only costs after settlement?

 

[APerry]

Hi Land,

My mistake, yes in that scenario 70% of end value is lower so that would most probably be what you would get. Every bank and most other lenders have a similer policy. It is most common for finance to be limited by the percentage of costs. It does seem very silly in some instances, especially very high margin projects, but with these you can generally get the land valued up and you can argue for increased equity to included as part of your 20% contribution, in your scenario B this would almost definately be the case.

Sumunro, most costs can be included in your contribution. It differs between lenders, but I always get clients to include a spreadsheet of every last cent they spend on their property and argue that it should all be included as part of their contribution.

Regards
Alistair

 

[GoAnna!]

My experience is that banks will lend close to 100% of costs as long as you have sufficient equity and it no more than 75% of end value. My experience though is prior to the current credit squeeze.

This was commercial finance at commercial lending rates, not residential.

I did go in with a strong business presentation to help it over the line.

I outlined my own experience plus the other key players. I was using a top builder Hansen Yuncken (just google them if you are not familiar), professional project management and I was able to demonstrate my knoweldge of that particular market. I also brought in all details of the proposed developement.

I was drilled by 2 bankers (one of them the regional managers who just happened to wander in mid meeting) and they asked me about my rental marketing plan, how my property fitted in the market and generally chatted I presume to get to know me and whether they thought I was capable of bringing the project together.

It was as much a sales pitch as a finance application. And this was with a business eager to do business.

They undertook their own quantity survey to establish market building costs (at my cost)

In the final amount they used these figures;

a) Building costs (verified)
b) Interest costs
c) Contingency
d) End valuations discounted as multi dwelling fire sale.

a plus b plus c had to be no more than 75% of d. In my case I put in about 3% of cash. The repayments then were capitalised duing the building process. Some banks will want you to put some cash in just so you have something at risk as well.

Things to look out for:
Your bank may or may not pay GST on builder's progress payments (my bank did but not all will)
Bank will retain enough to complete the development at any stage (which may require you to put your hand in your pocket)
You can negotiate terms far more than a residential loan
Development are riskly for both developers and bankers because to an extent you are punting on the future market. A blow out in time or costs can be very painful.

Hope this is of some help.

 

[stumunro]

thanks Alistair!!!

 

[Pablo]

Thanks Alistair - yes, the intention was to move into commercial lending as distinctly seperate from our personal investments.

I think Richard has confirmed what I was hoping.

If we were to buy a site with no DA approved, we would have to put our own money in to buy the site in the first place, obtain development consent, and then try and obtain finance for the construction cost based on the end value.

HOWEVER, if we wanted to buy a site which ALREADY had DA approval, then everything can be worked out, and provided it can be demonstrated that 100% of land purchase and construction costs is less than 70% of the end value, it should be possible to obtain 100% finance for the entire project.

I don't know if it is possible to go past 70% by levering off the builder's experience and previous projects, as well as our own growing experience?

Wouldn't you be struggling to find a deal with 30% profit left in it if it already had DA approval?

I have been told to sign the contract subject to finance and subdivision, then apply for subdivision at your cost and once approved then if there is enough profit in it the bank will approve finance. Allot riskier but allot easier to stay under 70%. Is there a better way of doing it?

Cheers
Pablo.

 

[grossreal]

hi pablo
yes there is
you don't buy the land you option it.
you can option my choice or you deposit and do a very long settlement a couple of other developers choices.
you pay the da cost or in my case the architect carries the cost to da and I pay him a higher invoice cost at that stage.
the option fee try for $1.00 lucky if you can get it usually about 5% mine is less then 1%
now for the tricks
first you need your build price.
second you need your end buyers
and then third you need your seed capital investors.
and then you work out margins and if it does not stack up its into the bin and start again.
and my bin is full at least twice a week

Wouldn't you be struggling to find a deal with 30% profit left in it if it already had DA approval?

I can give you 5 if you want them.
the trouble in this market is not the margin its the presales.
i will tell you what a lender will want on this deal
first at 4.5mil total cost
they will want to see 450k hard cash up front
2.25mil in presales.with 5% cash or 10% deposit bonds and most will vet those presales and they will go thru them more then your paperwork to make sure they are legit.
and they want to see a feasability that has over 21% margin in it
so if you can do the above then you have a deal.
this type of finance is not for the faint hearted.
as they strings get tighter then the guys that can get these thru lenders do and sorry to say the onces that can't starve.
out of 10 deals in the last 2 weeks only 1 is going thru and the rest are in the bin or being sold off as is.
unfortunately thats the market.
any thing over 3 mil will require presales unless you are throwing in 3 mil of external equity and anyone doing that is not a developer they are a speculator.
developing now is not the same as 2003 we are in a very tight lending market yes lenders want to lend but only if you meet the above requirements.
hope this helps

 

[Pablo]

Thanks Grossreal,

Great post, tried to give you kudos but I have to spread the love some more.

 

[APerry]

My experience is that banks will lend close to 100% of costs as long as you have sufficient equity and it no more than 75% of end value. My experience though is prior to the current credit squeeze.

This was commercial finance at commercial lending rates, not residential.

I did go in with a strong business presentation to help it over the line.

I outlined my own experience plus the other key players. I was using a top builder Hansen Yuncken (just google them if you are not familiar), professional project management and I was able to demonstrate my knoweldge of that particular market. I also brought in all details of the proposed developement.

I was drilled by 2 bankers (one of them the regional managers who just happened to wander in mid meeting) and they asked me about my rental marketing plan, how my property fitted in the market and generally chatted I presume to get to know me and whether they thought I was capable of bribging the project together.

It was as much a sales pitch as a finance application. And this was with a business eager to do business.

They undertook their own quantity survey to establish market busining costs (at my cost)

In the final amount they used these figures;

a) Building costs (verified)
b) Interest costs
c) Contingency
d) End valuations discounted as multi dwelling fire sale.

a plus b plus c had to be no more than 75% of d. In my case I put in about 3% of cash. The repayments then were capitalised duing the building process. Some banks will want you to put some cash in just so you have something at risk as well.

Things to look out for:
Your bank may or may not pay GST on builder's progress payments (my bank did but not all will)
Bank will retain enough to complete the development at any stage (which may require you to put your hand in your pocket)
You can negotiate terms far more than a residential loan
Development are riskly for both developers and bankers because to an extent you are punting on the future market. A blow out in time or costs can be very painful.

Hope this is of some help.

The most important point is that highlighted. Things have changed markedly during the last 6 months, particulalry for development funding. There have been some very strange policies appear amongst different lenders that are reslting in applications being rejected that would have sailed through not long ago. I can tell you categorically that unless you are particularly strong financially and the project is particulalry stong you will not get more than 80% of costs from a major lender.

I fail to see why they wouldn't lend 70% of end value, and if this covers all costs, where is the risk to the lender?

I tend to agree with this, particulalry where there are strong presales or the project is in a high demand area. But neither of us make bank policies.

Regards
Alistair

 

[Land]

Alistair, are the lending rates as a percentage of gross realisation vs. costs that you are referring to much the same as the table in this link:

http://www.m1.com.au/bus_pdl.asp

If so, I understand what you mean now Although, this table seems to indicate that between senior and mezzanine funding, one could achieve 80% of GRV, which would be perfect!

 

[APerry]

Alistair, are the lending rates as a percentage of gross realisation vs. costs that you are referring to much the same as the table in this link:

http://www.m1.com.au/bus_pdl.asp

If so, I understand what you mean now Although, this table seems to indicate that between senior and mezzanine funding, one could achieve 80% of GRV, which would be perfect!

Whats's iun that table is pretty accurate, however you should note that the upper end of the percentage of costs mentioned is 85%, this most likley refers to Bank Wests policy, but you should note that they very rarely will agree to go to this level. 80% is much more realistic, if you go above this you are likely to have trouble getting an approval whatever anyone tells you.

Mezzanine funding is available, but is also very difficult to get in the current climate, as a large number of Mezz funders have withdrawn from the market. You should also note unless the mezzanine portion is over $500K in total you will struggle to find a funder. Merzz funders also generally have strict presale requirements and some also have strict policies on percentage of end value.

I hope I don't sound like a wet blanket. I should also say that if you project is good enough you may well get up somewhere near what you are after, it is just unlikely to be easy.

Regards
Alistair

 

[GoAnna!]

I was with BankWest. They were eager for business in Victoria at the time.