What is construction finance?

 

Well, given it’s supposed to offer a workable, end-to-end funding solution, construction finance in Australia can provide more problems for developers than it should. Where many issues occur is around equity. The fact is that when you stick with banks and traditional construction finance providers, your options might prove to be inflexible.

 

That can cause a lot of frustration. Adequate finance should be tailored to the purpose. Different property developers and builders require various structures and have distinct advantages and challenges. The trouble with traditional construction finance in Australia is that it’s often one-size-fits-all. In a demanding, hectic marketplace, off-the-peg construction finance solutions rarely provide for a smooth, profitable project. In this article, we’ll answer a few points regarding what is construction finance? But we’re also going to look at one area where developers often hit a brick wall with banks and traditional construction finance companies – utilizing the equity resulting from an uplift in value from a DA.

 

Uplift in value from a DA: Using the resulting equity for ongoing project costs

 

If you’re an experienced developer, the chances are you won’t currently be considering your first construction finance loan. No matter how many successful projects you’ve completed, however, you may have come up against a very familiar problem several times over the years. You purchase land; then you go through the lengthy process of obtaining a DA so that you can push forward with a lucrative project. During the period between land purchase and the DA being granted, the value of your land has increased significantly. Let’s face it, the event isn’t unusual, and nor is it difficult to explain. Obtaining a DA is always going to make your land more valuable. Doing so ensures that the opportunity you first identified as profitable can proceed. You don’t need to be a property development genius to appreciate the process of obtaining a DA has added worth to what was once just a plot of land. It’s entirely logical. Yet, the one entity that seems to have trouble acknowledging that fact is the bank. You’ve likely had the conversation with traditional construction finance companies too often, and it may have felt like banging your head on a financial brick wall. It’s not just the value uplift from a DA, either. Many developers buy a plot of land, and between the lengthy DA process and other commitments, they might sit on the plot for months or years before they can begin a planned project. During that time, it’s likely that the land value will appreciate even without a DA application. Combine both of those factors, and many developers end up with sizeable equity they didn’t initially have. Unlocking can be a valuable tool for builders and property developers, but is there even a construction finance solution that allows you to do that?

Construction finance in Australia: Equity contribution and using the value uplift from a DA

 

You’ve got better uses for cash equity than ploughing it into a project that’s already worth considerably more than when you purchased land. So, how much equity might you need to get a new project out of the ground? And how can you put DA uplift equity to work? Let’s look at a recent example. Prudential Custodians helped a client who planned to undertake a residential apartment development in Northern Sydney. The project promised a healthy return, and the developer had already purchased land and gone through the time-consuming, relatively costly process of obtaining a suitable DA. Upon approaching the bank, they received approval and an offer to fund 70% of the project’s total development cost (TDC). The bank required the developer to contribute 30%. The bank ascertained that TDC on the 20-apartment development amounted to $11,000,000. That meant the developer faced an equity contribution requirement of $3,300,000—a sizeable drain on resources starting a significant project. In addition, the bank required the developer to achieve 40% pre-sales, meaning they needed to sell eight apartments off-the-plan. At that point, the client approached Prudential Custodians seeking a solution that utilized the uplift in land value from a DA. We went even further than that.

 

Construction finance loans in Australia: What is TDC?

 

At this point, it’s helpful to determine how the bank arrived at its construction finance loan offer. Banks and traditional construction finance providers tend to evaluate projects and funding according to TDC. In some ways, that makes perfect sense, but in the real world, when you’re trying to find the most cost-effective, versatile construction funding solution, it can leave you feeling like a lender isn’t helping you play to your strengths. Let’s look at the direct costs that constitute TDC:

• The land purchase cost
• Any land holding fees
• Council rates
• If you’ve applied for a DA, you’ll likely incur consultant fees
• Marketing costs, which can rise considerably if the bank specifies pre-sales
• The cost of construction and redevelopment
• Project management fees
• Construction loan interest
• Real estate agent fees

 

You’ll note that when we’re examining TDC, we’re thinking like a bank and using the land purchase cost. That’s because banks don’t tend to consider the alternative. Gross realization value and utilizing equity created by a DA application Now, let’s return to how a private mortgage manager like Prudential Custodians evaluated the same project. We looked at the project based on its gross realization value (GRV) for a start. Whereas most traditional development finance providers ignore the end value of a construction project, using GRV can provide massive benefits for constructors. Here’s how that worked for our Sydney client. GRV exploits the potential value of a project, not just the costs of site acquisition and completion. Not only that, but it allows a private mortgage manager like Prudential Custodians to unlock uplift equity too. A closer look at the Northern Sydney project revealed a sound basis for construction and a sizeable return on investment. All planning issues were taken care of, an experienced developer was in charge, and contractors were ready to proceed. The twenty apartments were projected to sell for an average of $850,000, totaling $17M. And here’s where it gets interesting. Even approaching an evaluation based on land purchase value, with TDC sitting at just $11M, the end value represented a sizeable return with ample contingency built into the project. Now, let’s look at the reality of the land value, based on the fact that the developer purchased it two years before and had recently been granted a DA for the apartment project. The original purchase price for the land was $2.5M. With a DA in place, an up-to-date valuation put the figure at $4.2M. The developer didn’t just have a lucrative project ready to break ground, but they were also sitting on an equity uplift of $1.7M. Combined with GRV rather than a construction finance solution based on TDC, Prudential Custodians was able to arrange a cost-effective, seamless construction loan option with zero pre-sales requirements. Not only that, but a GRV-based construction loan removed additional potential obstructions for the developer:

 

• The developer got to the site faster: 

 

Without the need for time-consuming pre-sales and the associated marketing activities, the developer could priories getting contractors to the site and the first phase of construction complete far quicker. Not only that, but the developer also doubled down on that increased efficiency and gained the prospect of maximizing ROI when it came to selling the apartments. From the start, the specification for the twenty apartments was high. Selected materials were of high quality, meaning the offered product sold for a significantly better price once potential buyers could view a completed apartment.

• Fewer project delays:

 

Part of the bank’s offer involved releasing construction finance funds according to build stages. The agreement specified an initial release after site clearance, further payments after slab completion, framing, first and second-fix, and project completion. After each construction phase had been completed, the bank required an inspection before funds could be released. It posed many potential problems for the developer, with the prospect of losing contractors if delays were getting the bank’s people to the site and money released. Prudential Custodians arranged a construction finance solution that utilized both the uptick in value from the DA and the end value of the project to provide more seamless funding throughout the project. Fewer avoidable delays ultimately meant less time on site and lower construction costs for the developer.

 

• An easier project exit: 

 

Construction finance companies can also cause headaches for developers when it comes to achieving a smooth project exit. Often, just when all the hard work is done and apartments, offices, or houses are ready to market to their full potential. Pressure comes from the bank to settle a construction loan. Coupled with pre-sales, that can result in a significant drain on profits. Before a developer can move onto a new project, they’re forced to provide buyer incentives – precisely when they should be exploiting the quality of their offering. It doesn’t make any sense. Yet, banks and traditional lenders offer construction finance options that repeatedly fail to value sales potential – and often actively work against it entirely. GRV– based construction finance loans from private mortgage managers like Prudential Custodians can help you maximize ROI and allow you to turn the equity in a finished project into a bridge to your next profitable venture.

 

The final word on flexible construction finance in Australia: Unlock the power of equity

 

Banks and traditional construction finance providers often provide products that can hinder day-to-day activities and even work against the pursuit of maximum ROI. For developers and builders, that can be a double whammy. They not only experience constant, ongoing drains on profitability, but projects can take longer to complete. Private mortgage managers like Prudential Custodians identify the strengths in your project and turn them into working capital that gets your development out of the ground faster, completed a lot more quickly, and gives you the space you need to maximize the end value of your project, too. It’s a pretty simple approach. We believe that Australian construction finance loans should make more sense to constructors and developers. With some construction finance companies and banks, your experience, concerns, and the value in your development proposal will all fall on deaf ears, but Prudential Custodians is different. We’re specialists in construction finance loans. We speak the same language as developers. We can help you unlock uplift from a DA and exploit the actual value of your project to make for a more profitable, less problematic build.