How development finance works
Traditional property development finance lenders often ignore the true potential of projects, which can lead to higher costs and longer build times for operators. So, how can you make your next development finance property more profitable? This article will look at how private mortgage managers can leverage gross realization value to provide more cost-effective funding options for developers.
It’s a subtle but hugely significant difference. No matter the ins and outs of your specific project, if you start asking yourself how you can make development finance work for you, rather than just worrying about how development finance works, you’ll avoid some potential pitfalls and make your next development finance property more profitable. Property developers face some crucial decisions when they identify a suitable project. The more experienced they are, the more likely they’ll look beyond factors like development finance interest rates. They already know that opting for the correct development finance partners could be the key to setting the tone and favorable operating conditions for the entire development. Choose development finance lenders with too many requirements and restrictive practices, resulting in numerous day-to-day delays. Hold-ups like that become high costs when it comes to development finance property. It can dwarf the costs associated with development finance interest rates. No matter how well a developer plans for problems and snags on-site, one thing is sure: time is money, and cash flow is the lifeblood of any successful development. Just like any other lender, banks must operate according to set conditions. Whether bank or non-bank, all financiers and development finance partners bring their requirements with good reason. Banks and private lenders have in common that projects must be viable and promise a reasonable return on investment. Where banks, traditional development finance lenders, and private mortgage managers differ, however, is in how they assess projects.
Development finance in Australia: Banks and TDC Vs. private mortgage managers and GRV
When a mortgage manager is equipped with the skills and knowledge to consider all the merits and advantages of a project, the easier things get for busy developers. Here at Prudential Custodians, we believe that property development finance should work for developers and builders, not against them. With the right solutions in place, projects can be more profitable and efficient – and create the ideal conditions for faster development with fewer delays and problems. The key to that is considering gross realization value (GRV). GRV (Gross Realised Value) is the value of development upon completion. GRV has two primary advantages for Australian property developers. Firstly, it allows mortgage managers to unlock more of the development potential in a property. Considering the end value means more funds become available at the start of the project. Mortgage managers look at the true worth in development from the outset. Developers can use the funds to get on-site quicker and get projects underway with fewer delays and associated costs. Secondly, making those funds available at the start of a project means fewer conditions and hold-ups as the development progresses. We already know that time is money, and efficiency throughout a lengthy project adds more profit. Not only that, but when a developer doesn’t need to constantly satisfy the ongoing requirements of a lender or bank, they can move between construction phases seamlessly, leading to less downtime and fewer problems getting trades on-site when needed. The engine behind all that flexibility – and the reason banks and traditional lenders can’t provide it – is GRV. While banks appraise property development finance based on the total development cost (TDC), private mortgage managers take a more developer-friendly approach and consider projects’ end value. In short, TDC is precisely how it sounds. It’s all the costs of developing a project to completion, nothing more. GRV gives developers more scope and contingency because it considers how much the development will be worth upon completion.
How banks provide property development finance – Pre-sales and TDC
While the most significant difference between a bank and a private development finance provider maybe how they use TDC and GRV to assess projects, it’s not the only difference. One of the most prohibitive aspects of dealing with a bank is pre-sales for many property developers. In reality, a bank may look at your project and agree to advance up to 70% of TDC. That’s maybe not optimal for every developer, but it might not be a total disaster if the lending conditions stopped there. Things can get highly tricky for many developers due to the additional pre-sales demands of traditional property development lenders and banks. Even when an agreement is limited to just 70% of TDC and takes little or no account of project end value, such lenders might require developers to achieve anything up to 50% in pre-sales, if not more. Pre-sales is when developers sell apartments, offices, or houses off-the-plan. Doing so can be problematic and costly for a couple of different reasons, and again, requirements like pre-sales can outweigh the costs associated with development finance interest rates. First up, pre-sales can see you tied up with marketing and sales for a period before you can advance construction and start working towards a successful project exit. Secondly, selling apartments and houses off the plan might not consistently achieve the broadest profit margin possible. For one, luxury developments sell best when potential buyers can look at and feel the quality of a build. On top of that, depending on market conditions, developers may want more flexibility to hold on to a selling environment with more buyer confidence, such as during a downturn or recession.
How to qualify for property development finance in Australia
Prudential Custodians take a unique approach to property development finance. We look at every project on merit, which means both the good and the bad. We look at both the project and its developer, whether there’s a return, a clear pathway to completion and exit, and any potential problems.
- Does this project make sense? The development needs to make sense. Mortgage managers want to see a project that makes sense. The path to completion should be clear, but a defined, realistic schedule should be in place.
- Return on investment: The mortgage manager needs to see that the project’s cost doesn’t outweigh the returns. Instead of pre-sales, you’ll need solid sales prospects. We look at where you’re developing, what you’re creating, and if your apartments, houses, or offices are likely to sell, plus what prices they’ll achieve.
- Who’s the developer? Private mortgage managers look at experience. If you’ve managed to get one or more successful developments across the finishing line in the past, you bring relevant expertise to the current project.
Private development finance in Australia: The benefits
The Prudential Custodians’ difference is that once we’re satisfied a developer and project are viable, we offer custom-designed solutions that minimize or eliminate the problems often associated with bank finance for property development:
- Minimal or no pre-sale requirements: Maximise ROI when you enjoy more flexibility before, during, and after projects. End-to-end financing solutions get you across the finish line, and you can even use the equity in completed projects to fund a new venture.
- Get to the site quicker: Without the burden of pre-sales and with faster, more straightforward applications for property development finance, you can get tools and workers to the site faster. We work hard to remove barriers at the start of projects.
- Lower deposits and equity requirements: We look at GRV so we can help you unlock more funding and cover more of your costs. Appraising projects based on end value means lower equity requirements.
- Use equity more efficiently: If you’ve increased the value of your plot by adding a DA or even if the market value has risen over time, Prudential Custodians can help you unlock that equity to fund development.
Traditional development finance lenders and how build times can spiral out of control
Opting for the wrong development finance lenders can cause several profit-sapping problems for Australian developers. It can be a self-perpetuating situation that worsens the longer the project runs. On the one hand, choosing a less than optimal development funding solution can lead to severe delays on site. Banks and traditional property development lenders release funds according to defined build stages. Typical agreements dictate developers can access a portion upon signing a contract when site clearance, groundworks, a slab, and drainage is complete, and then after framing, lock-up, first and second-fix phases, and completion. Banks and traditional property development finance providers must inspect and sign off before releasing money between each stage. To compound the issue, when those delays inevitably occur, developers with less contingency built into financing arrangements and subject to more stringent conditions can find themselves far less able to cope with spiralling costs and the demands of contractors. In the best-case scenario, that can lead to completion times getting set back significantly and ultimately higher borrowing costs, plus it does nothing for relationships with service providers. In the worst cases, developers cannot complete projects at all.
Property development finance in Australia: Choose a Specialist Option
GRV is powerful. Neither banks nor private lenders will take unnecessary risks, but in the current traditional lending climate, the fact is that for developers, TDC and high pre-sales requirements often leave a bad taste in the mouth. Many property developers feel that agreements lean decidedly one way, with developers enduring almost all of the burden and risk before, during, and upon completion of projects. They feel those adverse effects from the minute they apply due to a lengthy process and throughout the project when enduring repeated delays and waiting for funds. Then, when they want to exit projects, they are sometimes forced to sell apartments, offices, or houses quickly because a development loan term is about to end. Private development finance providers tend to bring more real estate expertise to the table – and your project. Banks operate across numerous verticals, providing personal loans, residential mortgages, insurance, vehicle finance, etc. In contrast, private mortgage managers like Prudential Custodians operate only within the commercial lending space. Our clients are specialists, and we speak their language. That allows us to assess the potential of projects and provide more good, workable property development solutions based on the needs of developers and the demanding environment in which they operate.
