Whether you’re an experienced property developer, or just starting out, it’s likely you’ll need finance to help you complete the development.
Property development financing could involve getting a single property development loan or getting various loans for different parts of the development.
What are property development loans?
Property development refers to the process of adding value to a property and includes:
- Building residential units or townhouses
- Subdividing land
- Building commercial structures like offices, industrial parks or shopping centers
- Building specialized centers like hospitals or schools
The development lifecycle
Although each development is different, they typically follow this pattern:
1. The initial stage
A developer could start at the very beginning by sketching out their idea, finding suitable land, and conducting a feasibility study.
The developer might also form a team, check the availability of architects and tradespeople, and talk to property professionals about the development.
2. The development stage
During this stage, the developer will need formal plans, licenses, and council approval, including development approval.
3. The construction stage
When the permissions are in place, the developer can start the construction phase. During this phase, the developer might hire a building company that supplies its own equipment and tradespeople, or buy the necessary equipment and hire the tradespeople themselves.
Getting finance
Finance can be obtained from banks, non-bank lenders or private lenders. Some loan lenders could give the developer a single loan for the entire project. Others may only finance a specific part of the development in which case the developer may need additional finance from other lenders.
Mortgage brokers can also help developers get property development loans.
To assess the developer’s application, most lenders will want:
- A feasibility study
- Detailed construction plans
- Projected costs and profits
- Proof of development approval
- Credentials of the developer and key personnel involved
- The expected completion date
- Security, like a mortgage over the land
Residential development loans
For small developments – up to four residential units on a single piece of land – the developer can apply for a residential development loan.
Because these loans are for smaller developments, the requirements are less stringent.
Lenders may accept 70% to 80% loan-to-value ratios and will choose what to finance, which could range from the entire development to only paying for the labor and materials.
Lenders may also require the developer to have a contingency fund to cover the costs of project overruns.
Commercial development loans
For larger developments, developers need commercial development loans.
Developers would most likely need to have a track record of successful developments, or partner with someone experienced.
Developers might only qualify to receive 65% of the funds they need and would have to provide the balance themselves. They could do this by using the proceeds from pre-sales or by leveraging their existing assets to raise additional funds.
How development and construction loans work
A development loan may cover the entire development or only the construction.
With both development and construction loans, the funds are not paid out in a single lump sum; they are paid out in stages.
If a developer-only took out a construction loan, the stages would typically include:
- The deposit stage includes paying the initial deposits and securing the staff and facilities.
- Base stage, which includes clearing the land, buying equipment, and laying the foundation.
- Frame stage, which includes constructing the framework of the structure.
- Lock-up stage, which involves fitting the windows, roof, and doors.
- Fixing stage, which typically includes all the internal fixtures and fittings.
The lender may appoint a quantity surveyor to assess whether each stage is complete, before releasing the funds for the next stage.
An advantage of receiving the funds in stages is only having to pay interest on the funds used, and not on the full loan amount.
Construction loans only last as long as the construction does – which could be four to twelve months if there aren’t major delays with getting workers or materials.
In contrast, development loans could last up to three years if the entire development is financed from start to finish.
Completing the development
If the developer runs out of money before the development is finished, they could get mezzanine financing. Mezzanine financing is subordinate to existing loans and will provide much-needed funds to complete or market a project.
A developer might also qualify for a residual stock loan. This loan helps the developer sell the final units of development.
If refinance home loan rates change, it’s also possible to refinance a property development loan.
Ultimately, the property development financing journey could end with the developer taking out a mortgage like with any real estate financing, or it could end with the developer walking away debt-free with the profits.
In conclusion
If you’re about to start development, why not first talk to a mortgage broker about your project?
A mortgage broker can help you:
- Decide which loan is the best for your project, for example, residential development, construction, or a commercial development loan
- Help you get all the required paperwork together
- Assist you with refinancing the loan if there’s a delay, or the construction progresses faster than anticipated
- Assist you to obtain additional financing like mezzanine finance or a residual stock loan if needed
