Innovative Funding Strategies For Innovative Developers
The Changing Face Of Property Development Finance
The strength of commercial property development has long been a significant factor in Australia’s economic growth. The building and construction industry generates hundreds of billions in revenue every year and supports over one million jobs which makes it our third largest industry — behind only healthcare and retail.
Finance for property development has traditionally been provided by the Banks without too much fuss. In 2016, it was estimated that the big four Banks held more than a 90 per cent market share of development financing. Established businesses were able to rely on previous lending and just say the word for the next development.
Demand for property development finance remains high as does the quality of borrowers, however there has been a fundamental change to the process in recent years. The Banks are pulling back from construction lending in a major way, brought about by the conditions imposed by APRA and the banking royal commission.
Bank construction finance offers favourable terms and interest rates, but the lending criteria is now much stricter due to the changes in legislation. Many developers are finding it difficult to get their projects financed by the Banks, or that their Bank approvals are at lower Loan-to-Value Ratios with higher pre-sales requirements.
As a result, property developers are increasingly looking to Non-Bank alternatives to provide critical funding for projects that are otherwise unappealing to the Banks. Higher interest rates are no longer the fear for developers, but the cost of delays. Private lenders offer more flexible lending criteria and much faster turnaround times.
If you are in need of construction finance for your next property development project then it is essential that you first consider all of the available funding options.
The Process For Traditional Bank Construction Finance
Major Banks are by design very sponsor centric. Their philosophy is that if we follow a good sponsor, then chances are that they will pick good projects and deliver good outcomes. Effectively, a Bank would first decide whether they are comfortable with the sponsor and only then would they look at the project and location.
Most major Banks have stringent rules and requirements with regards to loan serviceability, borrower experience, pre-sales and Loan-to-Value Ratios (LVR). The minimum requirements would typically be the borrower’s up-to-date financials, at least two previous projects completed successfully by the borrower, at least 100% debt cover in pre-sales and a maximum 65% LVR limit.
BANK CONSTRUCTION FINANCE
60% – 100%
Cover through the Net Proceeds of Compliant Pre-sales
Interest Rates from 3.49% p.a. and Line Fees from 1.3% p.a.
Are the Banks still financing property developments?
Yes, most are, although not nearly as much as a few years ago. Some of the Banks have put a complete stop to construction lending, and the rest have all significantly reduced their lending portfolios. They have also reduced their LVR limits, and they have increased their pre-sales requirements. This means that only a limited number of projects that “tick all the boxes” are currently being funded by the Banks.
What does Bank construction finance look like currently?
They still provide the lowest cost of funds
They have high pre-sales requirements, usually 100% to 120% debt cover in pre-sales
They will only accept minimal overseas pre-sales, typically 15% of the pre-sales requirement
They typically require 10% deposits for pre-sales
“New to Bank” customers or inexperienced developers will struggle to get their projects approved as the Banks are typically very sponsor focused
Very conservative Loan-to-Value Ratios (LVR)
Requires strong sponsors
Finance Rates: Their rate normally consists of an establishment fee (typically 0.5% to 0.75%), an Interest Rate (3.8% to 4.5%), and a Line Fee (1% to 1.5%)
Some Banks do not charge a line fee but will typically have a higher interest rate (6% to 7%), which makes the overall cost of funds essentially the same.
Are all Banks the same with their lending processes?
The short answer is No. Banks can be classified as major Banks (the big four), minor Banks and Credit Unions. While their rates are pretty much the same, the minor Banks and Credit Unions may be a bit more lenient with respect to overseas pre-sales, pre-sale deposits and LVR, but not significantly.
Their appetite for different types of deals also differ. For example, there are Banks that prefer land subdivision projects and would provide funding with no-pre-sales as long as it is not too large while others prefer to do only residual stock, etc.
It is important to note that Banks, like any other lender, have changing appetites from time to time. Just because you could borrow 80% of cost from your Bank two years ago does certainly not guarantee that they would do the same loan parameters for property development finance today.
When should I choose a Bank for property development finance?
Do you have plenty of equity (i.e. at least 30% of the Development Cost) and enough pre-sales to cover the debt, of which 90% of them are local buyers with 10% deposits?
Do you have a solid track record, and a good balance sheet?
Do you have or do you plan to secure 100% debt cover in pre-sales?
If your property development project “ticks all of the boxes” then you should go with a Bank. It is by far the cheapest source of funds.
When To Consider Alternative Project Funding Methods
There is a growing number of private lenders and mortgage trusts that are less stringent than the major Banks. These Non-Bank alternatives require minimum to no pre-sales (depending on project size) and provide up to 75% Loan-to-Value limit, and up to 90% of Total Development Cost. For the right business, Non-Banks will provide a favourable loan for property developments.
Non-Bank alternatives have been called upon more and more due to their project focused lending strategies. They primarily look at the outcome and the potential to get the project started sooner rather than later.
Although more expensive than the major Banks, being able to commence construction without a formal requirement for pre-sales results in significant cost savings in other areas, such as holding costs, marketing expenses and sales commissions. Using less equity will also significantly improve your Return on Equity and could allow you to do multiple projects at the same time.
NON-BANK CONSTRUCTION FINANCE
Up to $25 million
Interest Rates from3.99% p.a. and Line Fees from 2.75% p.a
What are Non-Banks?
The term “Non-Banks” is used for all funders that cannot be classified as a Bank or Credit Union. These range from Individual High Net Worth Investors to Large Private Mortgage Funds. They are typically not governed by APRA and are more flexible regarding pre-sale requirements and LVR. They are also faster and easier to deal with than the Banks, but are significantly more expensive.
What does Non-Bank construction finance look like currently?
They have a higher cost of funds
Lower pre-sales, often no pre-sales. The pre-sale requirement is directly linked to the cost of funds, i.e. a Non-Bank with a 50% debt cover requirement will be cheaper than a Non-Bank with a no-presale requirement
Higher LVR, ranging between 65% and 70% of LVR for the mainstream Non-Banks
More flexible regarding qualifying pre-sales, will accept more overseas pre-sales, and will consider pre-sales with 5% deposits
Less stringent regarding sponsor strength and sponsor experience
Finance Rates: Typically, 9% to 12% Interest Rate (which may consist of a combination of a Line Fee and Interest Rate), and a Lender Establishment Fee of 1.25% to 2%.
Are all Non-Banks the same?
Again, the short answer is No. Their rates and parameters vary vastly, and depend on the project, LVR and pre-sales.
For example, a Non-Bank may not require any pre-sales and provide up to 70% LVR for projects under $2 million, but may require 50% debt cover in pre-sales and only provide 65% LVR for projects above $2 million.
Others may have no pre-sales up to $15 million at 70% LVR, yet others prefer to work on residual LVR and not as a percentage of the debt. Most would provide 65% to 70% LVR, while very few, if any, would go above 70% LVR or 85% of cost.
Do Non-Banks only fund small projects?
No, there are quite a few Non-Banks that only operate in the $25 million to $125 million space. These lenders are often referred to as “Institutional Lenders”. These are typically Fund Management Firms with large property/mortgage funds.
When should I consider a Non-Bank for property development finance?
Do you have limited equity (i.e. only 10% to 20% of the Development Cost)?
Do you want to commence construction as soon as possible without securing any pre-sales, or with minimal pre-sales? Alternatively, do the pre-sales that you have consist of a significant number of foreign buyers or only 5% deposits?
Are you a first-time developer or relatively inexperienced?
Do you have a limited balance sheet?
If this describes your property development project then you should look to secure funding from a Non-Bank alternative.