How can I secure financing for my real estate development project?

Access to development funding is an integral part of the property development process. But capital is not always easy to secure. The world of development project finance is changing rapidly. Evolving financial markets, shifting public policy priorities, and the Covid-19 pandemic are all influencing the products and strategies needed to bring development dreams to life. In the wake of the 2018 Royal Commission into Banking, the big banks tightened their lending criteria. While this initially led to a wave of funding from private equity and second-tier banks, many of these lenders are also becoming more conservative.

Depending on the environment you are operating in, development loans can be harder to secure, and they are getting more expensive and restrictive. At the same time, pre-sales could also be harder to secure in some places, and certain developers are adapting to a build-to-hold investment model. When developers are looking to longer-term investors, like debt funds and equity partners, these lenders require greater transparency and accountability during development and operational management.

To compete for cash with lenders, developers must learn the language of investment management. But demonstrating financial discipline is increasingly difficult to do with simple spreadsheets.

The nuts and bolts of development finance

If you’re not familiar with the complexities of finance, sometimes sourcing the right funding can be a confusing process.

Development finance differs from ordinary investment finance, as you can usually borrow the ongoing interest as part of your finance package. This means you don’t pay interest during the construction phase, but the interest is added to the amount you owe at the end of each month.

At no stage will the bank allow you to exceed the total loan amount, and the interest is capitalised, so you pay interest on the interest . It is only when you begin marketing and selling your project that you commence repayments. This makes development finance a riskier proposition for lenders.

There are several types of loans that are designed to suit various project stages. These include:

• Acquisition: This covers the purchase, development application and pre-construction costs

• Construction: This loan typically gives you access to staged payments at each stage of a construction project, from slab to completion

• Investment: This loan is used if you are retaining your development as a long-term investment.

Looking at your loan-to-value ratio

How much it costs to develop a property can vary dramatically depending on your goals. But how much you can borrow is underpinned by a fixed formula. The amount you can borrow is known as the loan-to-value ratio or LVR.

LVR = Loan amount / Purchase price (or valuation of the property)

LVRs employed by the top non-banks have fallen over the last year as lenders become increasingly cautious and risk-averse. Just one recent report from Ashurst found developers need to find significantly more equity to get a bank loan, with average LVRs tightening from 62.5% to 50% in the first six months of the Covid-19 pandemic.

That means, depending on the project, you may be required to provide 50% of the equity to secure the loan.

Every lender will have its own criteria, terms and conditions, but when calculating how much finance you will need to consider:

• The value of the land

• Total build costs

• Solicitors and legal fees

• Agency and marketing fees

• Contingency costs

• Completion fees

• Brokerage and loan fees

Two questions to secure your development loan

Risk-shy lenders will expect you to answer two important questions:

1. Can I repay my loan?

2. Is my development viable?

Providing documentation to prove yourself to your potential lender is not always easy. The application process for large projects can take weeks and even months. Lenders will be looking at everything from your reputation and your track record to your feasibility study and financials. Here are just some of the key pieces of information to consider:

• Project information: Include a comprehensive site description, zoning and concept design

• Cash flow feasibility: Provide a full breakdown of your costs, from acquisition to sales, taxation to professional services. Lenders will check and challenge all your assumptions. Do the revenue, time and cost numbers stack up?

• Equity: Show evidence of sufficient cash or equity; the less equity you have, the higher the interest rate is likely to be.

• Presales: Most large projects are dependent on pre-sales to minimise the lender’s risk. This means a percentage of the development is pre-sold – sometimes as much as 60% – before the project can break ground. The funds from pre-sales can’t be used to fund your development and must remain in the trust.

• Credentials: Provide proof that your project team, builder and professional services are up to the task.

• Contingency: Demonstrate your capacity to meet cost overruns, regardless of water-tight contracts. Typically, 5-10% of your budget should be allocated to cover additional or unexpected costs during the construction project. Most lenders will expect proof of budget and cash controls and reassurance that you can cope with any budget blowouts.

• Operating income: Forecast realistic operational revenues and costs to generate a total return if your model is a build-to-rent opportunity.

• Security: Provide evidence that your projected returns meet market expectations. Lenders will want assurance they can get a return on their investment even if they must hold a fire sale.

• Progress reports: Show progress reports from your builder or project manager and updates to cash flow forecasts, financial projections or feasibility studies based on delays, budget blowouts or movements in the market.

In summary

Risk-averse lenders expect more than a back-of-the-envelope calculation or a few spreadsheets. They expect trustworthy and transparent financial models so they can do their due diligence.

ARGUS EstateMaster and ARGUS Developer are the industry-standard for financial modelling, which can be applied throughout the development lifecycle. Feasibility studies can be shared with potential lenders, and underlying assumptions can be tested, offering full transparency behind every report.

• ARGUS EstateMaster: Once you input your costs and revenues, you can calculate key performance indicators, including residual land value, development margin and profit, net present value and internal rate of return to help you evaluate development opportunities.

*Purpose-built for the Asia Pacific and the Middle East region

• ARGUS Developer: Build and leverage pro forma templates, set up a project timescale with configurable stages to suit your project, link phases and model phase dependencies, test scenarios for proposed developments, and bring transparency to risks.