Property development has been described as the business of buying land and buildings and then improving them so that the selling price is higher than the cost. And the finance for this? It will depend on the type of development project being undertaken - whether it is residential, an apartment complex or a high rise building. An experienced and professional financial consultant will offer much-needed assistance on property development finance in obtaining a hassle-free method to obtain this funding.
The consultant or broker will pave the way to obtain the finance required by doing the “research and paperwork” for obtaining a bespoke deal.
- Development loans: These loans are short-term, but more of a specialist option, for financing the building of new properties or renovating existing ones.
- They usually come in 2 parts - one for purchase of the development site and the other being a loan to pay for the cost of the work associated with the project. The second part is usually paid in stages, as the work is completed, rather than a lump-sum payment.
- The loan amount will depend on the value of the property before the renovation, the cost of the building work and the value of the property after work is completed.
- There will be fees involved which will depend on the amount borrowed, the percentage of the loan amount against the total costs - the current value and the development costs and the period for which the loan is required.
- An Offer of Finance is drawn up with the terms agreed upon.
- Repayment of the loan is usually made before the agreed term from the sale of the property. An extension can sometimes be provided, but that will be subject to additional fees.
- Commercial loans:
These are business loans for buying and renovating the commercial property. They are usually:
- Owner-occupied - when a company wishes to buy the currently rented property or buy a new property.
- Buy to rent - when a property is bought to rent out for residential or commercial purposes
The deposit required is usually between 20% to 40% of the total value. The interest rates are usually higher and will depend on the total value of the property, loan amount and period and credit history of the investor. The period of commercial loans range to about 20 years but the amortization period is often longer than the loan term.
- Bridging loans:
These are required when one property needs to be bought before the sale of another is finalised. They are short-term loans and are repaid when one of the properties in the agreement is sold or refinanced. They are good for auction purchases, to refurbish the property for sale or rent. Sometimes, a property developer finds the funding from various sources is proving to be more expensive and difficult to manage. A bridging loan can help consolidate the loan to one place till the property is sold. The interest on these loans is rather high and another property or land will be required as collateral.
- Mezzanine loans:
These are also short-term loans which can be used to top up the main loan and the equity. A mezzanine loan is secured by an ownership interest in the company that owns the property. The mezzanine lender will take second place behind the main finance lender known as the “senior debt” lender. In case of default, the senior debt lender will have the first right to be paid. Because of the risk to the mezzanine lender, equity in the company is assigned should the terms of repayment not be met.
- Early access to the capital
- Borrowing less leads to a higher return on equity with lower debt levels.
- Interest payments are usually tax-deductible.
- Risks to be considered if the deal does not work out - the developer could be in debt and have to give up equity.
- Detailed documentation to prove track record and experience, granted planning permission and evidence of the “senior debt” lender will have to be given.
Property development is rising on the popularity ladder due to the many advantages such as:
- Finance for property development enables larger projects to be taken on.
- As capital is retained, additional projects could be considered with the money saved
- ROI - return on investment will increase
- In the unlikely event of the project failing, the risk of the investor’s own money will be less.
However, the disadvantages should also be taken into consideration.
- Funds loaned are on an LVR (Loan-to-Value) ratio which is a percentage of the value of the property, so the balance will need to be obtained.
- The lender may visit the site throughout the stages, with a monitoring surveyor to ensure that the development is going according to plan.
The budget will need to be closely looked into, to cover the costs and fees, including arrangement, property evaluation and legal. With the guidance of an experienced consultant in property development financing, the investor will come out tops with the best deal possible!