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Development Finance Guide

Discussion in 'Property Finance' started by Shahin_Afarin, 21st Jun, 2015.

  1. Shahin_Afarin

    Shahin_Afarin Residential and Commercial Broker Business Member

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    I receive a fair number of queries from forum members on development finance so instead of repeating the same information each time I thought I would create a thread that developers can use (and I can refer them to :)).

    Multi unit (Construction of 3 or more dwellings) development can be financed under either Residential Finance or Commercial Finance. Each of these methods of finance has very different criteria, processes, benefits, disadvantages and of course costs.

    Here are a few differences between the two:

    1. Costs – this includes but not limited to Application Fee (approximately 0.50% of the total loan amount), Valuation Fee (Approximately $3-$5k for smaller projects and much more for larger projects), QS report $3k-$5k (although can be requested under Residential Finance as well) and higher interest rate (approximately 1.0-2.0% higher than carded resi rates)

    2. Presales – commercial finance will require presales on the project. Only a small number of lenders accept no presales but you do need to demonstrate the ability to service the debt without the use of proposed rental income. Under residential finance you do not require presales and you are able to use the proposed rental income of the dwellings.

    3. LVR – normally residential lending is 80% of the “as is” or “in one line” valuation. Commercial finance is up to 70% of the “end value”. Commercial lending allows developers to capitalise the interest but this is factored into the LVR.

    4. Up to 4 units can be financed via residential lending – anything over 4 units and it is deemed commercial. There is one lender that will consider 5 units under residential lending but its very much on a case by case basis.

    When it comes to commercial finance – the bank takes a more conservative and stringent approach to the application. As a minimum they will require the following information:

    1. Customer background and experience – resume/CV of the sponsors, specific to their development experience. The lender will need to see the last few projects (i.e. address, description, gross realization, profit, cost/time to build, if there were overruns and how they were managed)

    2. Builder background – depending on the scale of the project the lender will require information on the builder used. If the project is high scale, i.e. 50 plus units then most lenders will require the builder to be on the lender’s panel. If the builder is not on the panel then they would need to do a presentation to the lender to come on board.

    3. Full details of the project – the lender (and the valuer) will require plans, DA approval, project feasibility (lenders will need to see a minimum of 15%-20% profit – this includes total project costings, including land, construction contingency, capitalization of interest, council fees, stamp duty, etc), Building Contract/Tender, marketing plans (if available), copy of the Pre Sale contracts (if available/applicable), copy of pre lease agreements (for commercial/retail developments) and QS report.

    Note if the customer is doing an owner build then the banks will generally lender up to 60% of the “end value”.

    This is a high level guide to development finance – the boundaries can be pushed depending on of the overall strength of the proposal.
     
  2. Redom

    Redom Mortgage Broker Business Member

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    Brilliant post champ - very very useful and relevant information. I may refer my calls on the same question over to this post too! :p
     
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  3. opal3259

    opal3259 Well-Known Member

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    Hi Shanin,

    Great post - very helpful.
    Dumb question of the day for you.... can you elaborate a little on the valuation side for resi?

    You mentioned '80% of the “as is” or “in one line” valuation'

    About to embark on a 4 townhouse project and trying to work out how the valuations for the properties will be worked out.

    Does the valuer look at the project and try to come up with a figure based on comparable recent sales?
     
  4. Shahin_Afarin

    Shahin_Afarin Residential and Commercial Broker Business Member

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    Hi Opal,

    Its actually a really good question because this is the part that stuffs up a lot of developers.

    When the valuer receives instructions to value a 3/4/5 unit site - they will provide 2 valuations. One is based on the end value and the other based on as is.

    So lets use an example - say you are building 4 identical villas and they are worth $500,000 each. The end valuation is going to be $2,000,000.

    The valuer is then going to provide a valuation based on 4 units on a single title. Therefore this figure is going to be considerably less. There is a formula involved in calculating this figure (which includes GST, selling costs, holding cost, interest, etc. So this figure is going to be approximately $1,500,000. Note I'm giving figures as an example.

    So the lender is going to be give you the lower of the land plus construction or the valuation of $1,500,000. On a case by case basis you may be able to get the higher figure of the 2.
     
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  5. albanga

    albanga Well-Known Member

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    Great post Shahin.
    You did however mention that 3 or more can be financed as either commercial or resi and that both have benefits and disadvantages.

    Reading over the remainder of your post though I could be mistaken but I saw no benefits to using commercial except for when that is your only option (5 or more).

    Have I missed something? Why would someone choose a commercial loan for a 3-4 unit development?
     
  6. Blacky

    Blacky Well-Known Member

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    Generally due to the fact that you can capitalise interest.
    Most commercial dev finance will be done using commercial bills. At times commercial interest rates can actually be lower than resi - however, this is rare and unique opportunities.

    It should also be pointed out that very few brokers have the right connections to be able to fund large scale developments. Most will say that they can, but in reality they can't.

    In the past StGeorge and Bankwest were the major players in the large development scene. Followed by Macquarie, CBA and few others. Im not sure if this remains the case.
    StGeorge and BW had dedicated teams for large scale developments, from lending teams right through to dedicated credit managers/decision makers.
    Generally if you couldn't get your deal through the bank - it would be wise to re-visit the project. This is a different standpoint from most finance transactions where it is just a matter of finding the bank who would approve it. In general these guys actually know what they are doing.

    Blacky
     
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  7. klabat

    klabat Well-Known Member

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    Is there any lenders that will do 80lvr on commercial? or is that a case by case scenario?
     
  8. Blacky

    Blacky Well-Known Member

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    80% of what?
    On completion?
    Hard costs?
    Contract cost?
    IOL (in one line)

    If you have the 'resi lending book' and are looking at commercial - throw it out. It has no place here.

    Blacky
     
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  9. albanga

    albanga Well-Known Member

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    @Blacky
    Thanks for your detailed response. Can I just confirm what you mean is the major advantage on a commercial lend you do not actually have to pay down the interest. It just continues to capatalise on the loan resulting in no cashflow issues during the development stage after which is completed is sold to pay down the debt?

    If so then yes I see how this could be a major benefit, particularly given the unknowns that ho along with bigger builds. In this scenario you could weather delays (pardon the pun) a bit more as your not paying back the huge loan each month.
     
  10. Blacky

    Blacky Well-Known Member

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    @albanga
    Yeah, that is largely about it.
    For small developments there probably isn't much benefit in going commercial. The complexities of the commercial application and costs usually make it less attractive.
    Also - for the most part commercial lenders aren't really all that interested in $2-3mil of lending. Unless the deal is very easy, and they can push it through quickly. Anything which may not look easy, just isn't worth their time spending on. For the most part commercial bankers minimum loans are around the $10mil mark. Anything below that gets handled by the 'small business' or 'retain' arms of the bank.
    Even a $10mil loan is a lot of work for little reward.

    In saying that we went commercial on the BlackMinster JV. A couple of reasons.
    1) the deal was pretty strong. With good cash equity upfront, comfortable LVR's and full loan servicing demonstrated (even though we are capping interest).
    2) GST is bank funded.
    3) We have good direct connections with commercial bankers. I am an ex-commercial banker and my Brother is a commercial banker. My brother does this for a living (I was more on the operating business side of finance, rather than property).

    My brother actually completed the loan application (on the banks application forms), completed the submission and sent it to his mate (who co-incidently used to report to my brother). All his mate did was have a quick read, and sent it to the credit department.

    Also remember that the majority of large developments will require pre-sales, usually to a level sufficient to full clear the debt, before any construction finance will be given.

    Blacky
     
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  11. Shahin_Afarin

    Shahin_Afarin Residential and Commercial Broker Business Member

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    Commercial lending is a completely different beast - generally speaking I don't see a lot of benefit to commercial lending for small projects (3-5 unit developments). The benefits of commercial lending really come into play on larger scale developments.

    For example, commercial lending requires you the developer to do QS reports (as do some not all residential deals). It is expensive and creates potential issues. The QS report generally takes a while to prepare which delays when the builder is paid so this expectation needs to be set. Builders don't like getting paid late. The initial QS report costs approximately $3k and each inspection thereafter costs approximately $700 - $1000. Some lenders will require a QS report at each stage and others will require 3-4 inspections. Either way its expensive. Now compare this with residential lending which potentially carries no valuation fee, no QS report or QS inspection fees, no application fees, etc.

    The other issue is that the builder may invoice say $500,000 worth of work but the QS may say that only $450,000 worth of work has been completed in which case the bank will only pay out $450,000 and not the full $500,000 so you either have to position this with the builder (good luck) or pay the shortfall from your own pocket which goes back to why its important to have reserve funding as a developer.

    Presales is also a killer with commercial lending. Some lenders will accept no presales provided you can service the end debt without the use of potential rental income but most will insist on presales. This works with a large scale development but not with small scale developments (IMO).

    Commercial lending can work but generally speaking I would try and make 3-5 unit developments work under residential lending.
     
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  12. He Man

    He Man New Member

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    Thanks Shahin. You and the many other regulars on this site provide very useful info. Appreciate your effort.
     
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  13. iDex

    iDex Active Member

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    What are the interest rates like now for commercial development loan?
     
  14. Blacky

    Blacky Well-Known Member

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    I have a peice of string. How long is it?

    Often a commercial development loan will be funded using commercial bills.
    Rates are based on
    BBSW or BBSY - currently around 2%
    Margin - depends on the deal. Somewhere between 1% to 3.5%.
    Total interest rate 3%-5.5% (charged on the drawn amount)
    Add - Line fee (charged on the loan limit) 0.5% to 2%
    Establishment fee - 0 to 1%
    Valuation fees $2,000+
    QS fees
    Any other costs they can come up with.

    So you could be paying anywhere between about 3% up to 10% depending on the deal.

    Blacky
     
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  15. Shahin_Afarin

    Shahin_Afarin Residential and Commercial Broker Business Member

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    Circa mid 6% but its going to be dependent on the strength of the application - sponsors' assets, income and liability position and the experience of the sponsors.
     
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  16. Blacky

    Blacky Well-Known Member

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    Shahin - mid 6% is the interest rate, however, it would not include all the other finance costs involved in getting a commercial dev deal up and running.

    Am I correct?

    Blacky
     
  17. Shahin_Afarin

    Shahin_Afarin Residential and Commercial Broker Business Member

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    Hi Blacky absolutely - it doesn't include all the fees associated with commercial lending. Your summary is spot on - QS reports are going to be around the $5k mark.
     
  18. Big Daddy

    Big Daddy Well-Known Member

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    Is it still the case that there are residential lenders for 4 unit finance? If so, who are these financial institutions ?
     
  19. Blacky

    Blacky Well-Known Member

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    Yep - most of them.
    Some will limit it to only 3units though.

    Many ways to skin a cat though. So you would need to engage a decent broker/banker to outline your requirements to see if they match up with the banks policies.

    Otherwise it is down the commercial finance route.

    Blacky
     
  20. Shahin_Afarin

    Shahin_Afarin Residential and Commercial Broker Business Member

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    Just an update in the development finance world - lenders (namely ANZ, Westpac and CBA) are pulling right back on land banking sites. This is direct results of the looming oversupply in the unit market.

    Lenders are trying to limit their exposures (which already is quite high).