How much cash do you need for a development? Financing a development

[BLTN]

I'm just wondering how much cash you actually need to fund a development from start to finish (assuming you can get the required amount of finance of course). Consider the following hypothetical situation:

Land: $500K
Purchase costs: $25K
Build: $700K
Interest rate: 5%
Holding period: 18 months
Loan deposit: 20%
Build deposit: 20%
Holding costs (= total loan * 5% * 1.5): $72K (this is an overestimate as I'm fairly certain you don't have the full construction loan from the get go...)
Total cash = Deposits + purchase costs + holding costs = $337K??

Questions

- Can you borrow for the purchase costs to reduce the cash required for the development?
- What %age do you typicall borrow for a construction loan and does this have a different interest rate?
- Do construction loans incur LMI and if so and what percentages?
- Are there any other things I've missed that would increase the cash requirement, and if so, can they be capitalised into the construction loan?

Cheers

 

[Terry_w]

Sounds like you mean a small construction project.

generally 90% (maybe 95%) of land value and fixed price contract. LMI would apply with rate varying depending on size and LVR.

 

[Shahin_Afarin]

Depends on if you are talking residential or commercial lending because deposits and process with differ greatly. You are most likely talking about a project that would fit with residential lending.

If thats the case then your biggest issue is going to be the valuer valuing the units in a single line versus what they would be worth individually - this will dictate a lot of things including the minimum deposit required.

So question is how many dwellings are you building in this hypothetical scenario?

 

[BLTN]

Depends on if you are talking residential or commercial lending because deposits and process with differ greatly. You are most likely talking about a project that would fit with residential lending.

If thats the case then your biggest issue is going to be the valuer valuing the units in a single line versus what they would be worth individually - this will dictate a lot of things including the minimum deposit required.

So question is how many dwellings are you building in this hypothetical scenario?

Most likely residential lending (either 3 or 4 unit build).

Basically I'm just trying to figure out all up, how much cash I would lose through a development.

e.g. For a buy and hold strategy, you just lose the deposit (say 20%) and the purchase costs (although my question remains whether you can capitalise these into the loan, or if this will incur LMI).

e.g.2 For a reno, you lose the deposit, the purchase costs and the reno costs (although you gain equity through the reno if you get it revalued).

e.g.3 For a development, you seem to lose the most cash (although gain the most equity), but I'm trying to figure out just how much. I'm most likely not going to sell at the end of a development due to tax implications, so I'm trying to figure out my strategy going forward with regards to future deposits and future developments.

Thanks guys

 

[sanj]

i would also include a good chunk for contingency, especially if it is your first development.

you will need less immediate cash if youre just doing a build strata and getting the builder to do it all as opposed to subdividing it upfront and then undergoing construction.

 

[Chomp]

Depends on if you are talking residential or commercial lending because deposits and process with differ greatly. You are most likely talking about a project that would fit with residential lending.

If thats the case then your biggest issue is going to be the valuer valuing the units in a single line versus what they would be worth individually - this will dictate a lot of things including the minimum deposit required.

So question is how many dwellings are you building in this hypothetical scenario?

Can you please explain "a single line versus what they would be worth individually" in more detail ?

Chomp

 

[Shahin_Afarin]

Can you please explain "a single line versus what they would be worth individually" in more detail ?

Chomp

So let's say you are constructing 4 villas and they are worth $500,000 each if you were to sell them individually. That would give you a total of $2,000,000. So when you do the finance under residential lending this is how people think the valuation is done, i.e. how much they are worth individually and then the total. This is incorrect.

Valuations are done in a single line which means the valuer will say "ok so if the @#$% was to hit the fan and we have to sell all 4 villas still under the one title (because DA says you need to build first and then strata or torrent title them or in WA green title) what will they sell for?".

Now if you were to put them in auction as 4 dwellings under the one title - there is no way you are going to get $2,000,000. You will get say 20% less so thats $1,600,000. So the valuation is going to come back at approx $1,600,000.

Bear in mind I'm giving approx figures and there are no hard and fast rules when it comes to valuations.

 

[Shahin_Afarin]

Most likely residential lending (either 3 or 4 unit build).

Basically I'm just trying to figure out all up, how much cash I would lose through a development.

e.g. For a buy and hold strategy, you just lose the deposit (say 20%) and the purchase costs (although my question remains whether you can capitalise these into the loan, or if this will incur LMI).

e.g.2 For a reno, you lose the deposit, the purchase costs and the reno costs (although you gain equity through the reno if you get it revalued).

e.g.3 For a development, you seem to lose the most cash (although gain the most equity), but I'm trying to figure out just how much. I'm most likely not going to sell at the end of a development due to tax implications, so I'm trying to figure out my strategy going forward with regards to future deposits and future developments.

Thanks guys

Based on the figures you have provided I think you will need around $457k cash and this is no including holding costs as this is separate. This is an guesstimate based on the following calculations:

End valuation $960,000 (the bank is going to take the lower of the land plus construction or valuation) and this is 20% less than $1.2mil since the valuation is done in a single line.

Costs are $500,000 (purchase) plus $25,000 (stamp duty) plus $700,000 (construction) so thats a total of $1,225,000. Minus the loan (which will be 80% of $960,000) $768,000 - this will leave you with a funds to complete of $457,000.

This does not include holding costs, DA, CC, etc. So that would all be on top of the $457,000.

If your valuation comes back higher then this of course would reduce the deposit required.

 

[D.T.]

Pricey

 

[Shahin_Afarin]

Pricey

If it was easy then everyone would be doing it.

 

[mrdobalina]

Pricey

It takes money to make money (... well.... equity anyway).

My understanding of the financing is the bank will lend 80% of inline valuation. I.e. 80% x (cost of block + cost of construction) = $960k. The rest needs to be capital injection through cash or equity.

 

[Colin Rice]

Their is a lender in WA that will do the deal on end value via build strata.

This allows you to potentially put in very little of your own funds.

They did do 4 units as of 31/6/14 but have pulled back to 3 due to APRA intervention, bless em!

 

[Chomp]

So let's say you are constructing 4 villas and they are worth $500,000 each if you were to sell them individually. That would give you a total of $2,000,000. So when you do the finance under residential lending this is how people think the valuation is done, i.e. how much they are worth individually and then the total. This is incorrect.

Valuations are done in a single line which means the valuer will say "ok so if the @#$% was to hit the fan and we have to sell all 4 villas still under the one title (because DA says you need to build first and then strata or torrent title them or in WA green title) what will they sell for?".

Now if you were to put them in auction as 4 dwellings under the one title - there is no way you are going to get $2,000,000. You will get say 20% less so thats $1,600,000. So the valuation is going to come back at approx $1,600,000.

Bear in mind I'm giving approx figures and there are no hard and fast rules when it comes to valuations.

ok so lets assume that you have created the 20% equity when you have finished construction and the titles have been received. You have paid 20% deposit already and also created 20% in equity, Is it possible to refinance and get your initial cash back ?

 

[Chomp]

Their is a lender in WA that will do the deal on end value via build strata.

This allows you to potentially put in very little of your own funds.

They did do 4 units as of 31/6/14 but have pulled back to 3 due to APRA intervention, bless em!

Hi Colin, who is that ?

 

[westminster]

End valuation $960,000 (the bank is going to take the lower of the land plus construction or valuation) and this is 20% less than $1.2mil since the valuation is done in a single line.

Costs are $500,000 (purchase) plus $25,000 (stamp duty) plus $700,000 (construction) so thats a total of $1,225,000. Minus the loan (which will be 80% of $960,000) $768,000 - this will leave you with a funds to complete of $457,000.

This does not include holding costs, DA, CC, etc. So that would all be on top of the $457,000.

If your valuation comes back higher then this of course would reduce the deposit required.

I think it would be possible get better than 80% LVR on 3 dwelling deal. I agree that valuation will be done inline and therefore max value may be $960k HOWEVER I think BLTN through a good broker should be able to get 85 or 90% LVR

At 85% LVR it would be $816k = 384k skin in the game
At 90% LVR it would be $864k = 336k skin in the game

However I think it's probably time for BLTN to visit his broker and run the numbers properly even on a theoretical situation.

 

[BLTN]

Ok, so this is totally different to how I would have thought it would work.

I was under the impression you would get a loan for the property and then a separate construction loan.

That seems ridiculous if the bank will only give you a loan of x% of 20% less than your total land + build costs. Because it is based on the total, they effectively devalue your land.

Eg:

Land: $500K
Build: $700K
Valuation: $960K

If you assume that the valuation on the land comes in at $500K, this means that they are assuming that the $700K you spend on the place is only adding $460K of value?? That seems ultra conservative to me.

This also throws out my numbers considerably. I have a lot of cash, but not THAT much cash. If this is how all banks work, developments with higher build costs are going to be next to impossible, due to the incredibly low %age that the banks appear to recognise in their valuation.

As a separate issue, does this mean that you take the full loan from the start, even though you won't be paying for construction until later on?

I guess it doesn't really matter if you have an offset facility.

 

[westminster]

It's not hard and fast though which is why I suggest you go see a broker and get some hands on information.

You would be getting 2 loans so the vals might come in differently and there are banks who approach it more leniently.

 

[Shahin_Afarin]

ok so lets assume that you have created the 20% equity when you have finished construction and the titles have been received. You have paid 20% deposit already and also created 20% in equity, Is it possible to refinance and get your initial cash back ?

Short answer yes but as mentioned they need to sit on separate titles.

 

[Shahin_Afarin]

I think it would be possible get better than 80% LVR on 3 dwelling deal. I agree that valuation will be done inline and therefore max value may be $960k HOWEVER I think BLTN through a good broker should be able to get 85 or 90% LVR

At 85% LVR it would be $816k = 384k skin in the game
At 90% LVR it would be $864k = 336k skin in the game

However I think it's probably time for BLTN to visit his broker and run the numbers properly even on a theoretical situation.

You can theoretically get 95% on a 3 unit site but LMI would be huge $30k-70k depending on LVR and loan amount.

LMI aside the bank would question why you are doing a 95% or 90% lend and whether you have adequate funds to mitigate risks associated with that size and type construction. If you have no further funds then credit wouldn't consider this (doesn't matter if you are a super cooper broker or not) and if you do have plenty of funds then again we would question why you are going LMI.

That said each situation is unique and you can certainly go above 80% but you are playing with fire if you don't know what you are doing and going above 80%.

 

[Shahin_Afarin]

Ok, so this is totally different to how I would have thought it would work.

I was under the impression you would get a loan for the property and then a separate construction loan.

That seems ridiculous if the bank will only give you a loan of x% of 20% less than your total land + build costs. Because it is based on the total, they effectively devalue your land.

Eg:

Land: $500K
Build: $700K
Valuation: $960K

If you assume that the valuation on the land comes in at $500K, this means that they are assuming that the $700K you spend on the place is only adding $460K of value?? That seems ultra conservative to me.

This also throws out my numbers considerably. I have a lot of cash, but not THAT much cash. If this is how all banks work, developments with higher build costs are going to be next to impossible, due to the incredibly low %age that the banks appear to recognise in their valuation.

As a separate issue, does this mean that you take the full loan from the start, even though you won't be paying for construction until later on?

I guess it doesn't really matter if you have an offset facility.

Once you have the plans, building tender and DA then order an upfront valuation and see where you stand. From there you can calculate how much funds you need.