My Development is Bankable, but who will fund it?

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By Sam Oughton

Thinking of trying your hand at property development but don’t know where to start? Many of today’s established large-scale developers started out in a similar position, so rest assured – you’re not alone. This blog is to assist you with gaining an understanding of what is required to get a development underway and what you can expect from the various lenders in the market.

Demand for new builds in New Zealand remains strong, with the assistance of their exemption from the recent policy changes to tax deductibility and LVR restrictions for investment properties. The surge in demand over the past few years has made development an attractive option to those who have a feasible project and a sufficient level of equity to get the project off the ground. Wondering if your development is feasible? Run some numbers by downloading our feasibility calculator here.

So, you have a development that is feasible – great news! But who is going to finance it? This is dependent on many different metrics that are specific to your development. The most important factors tend to be the level of lending relative to the total cost of the development (LCR) and the on-completion value (LVR). These are essentially dependent on how much equity you are willing to put into the project. Other factors include development margin, exit strategy (sell or hold) and your development team. Interested in learning more about key terms and industry jargon? We cover this and more in our Development Finance Guide.

Top 4 risk considerations to lenders

  • Loan to Cost Ratio (LCR) - This is a function of how much equity (cash) you are contributing to the project. It is calculated as the total loan required divided by the total cost of the project (Land, Civil Works, Build Cost, Professional Fees, Local Authority Fees, Contingency and Finance Costs).
  • Profitability/Development Margin - This is what you will profit from the development after all costs, including repayment of the development loan
  • Exit – This is what happens on completion. Generally, this will be to sell all the properties within the development. This can either be either off the plan (presale) or once the development is completed
  • Development Team – These are the key professionals involved in the development. These include you as the developer, builder, QS, valuer etc.

With the above in mind, what lender will your development fit with?

Banks

Although probably quite self-explanatory, Banks are first tier lenders including ANZ, ASB, BNZ, Kiwibank and Westpac. They tend to offer the most competitive rates for developments but have more stringent lending parameters than those in the near and non-bank lending spaces.

LCR – Banks target a LCR of 70% - i.e., 30% equity into the project. They may stretch to 75% for strong projects, however, this is on a case-by-case basis. For the same reason they may seek below 70% for certain projects.

Development Margin – Banks target a development margin of 25%+ however will allow some developments to fall under this – if you are sitting around 20% most banks will consider this.

Exit – This is the method of repayment of the development debt. It is either through sales OR restructure to an investment facility.

Sell Down – This is the most common exit for a development, the sale of the properties to repay the lending. In the current environment the target for main banks is 100%+ debt cover (i.e. $1.00 of NET sales for each $1.00 of debt). Net Sales means the sale proceeds after GST and sales costs (agency fees etc). The banks will seek confirmation of this prior to advancing and development lending (pre-sales).

Investment on Completion – This is if you are looking at holding some (or all) of the properties upon completion of the development. This is not frequently considered by the banks as it is a more risky option and difficult to manage. In simple terms, the investment proposition on completion needs to be strong (low LVR, good servicing, pre-leases etc.).

Development Team – This is a big one for the Banks and they require your team to be rock solid. This means your team will need to include:

  • Bank appointed Quantity Surveyor (QS). Banks have panel QS firms that they work with. The QS’s role in the project is to produce a ‘pre-construction report’ which covers off the below amongst other things. They also verify the costs to date on the project and arrange the drawdowns for the bank.
  • Bank appointed Valuer. You will require a valuation ‘As Is’ and ‘As If Complete’. It is important the party doing this is acceptable to the bank – this will depend on project location and product type.
  • Builder – Per the above, the bank will want a builder with good experience and capability. The QS will comment on this for the bank and the bank will take their advice.
  • Sponsor – This is you. The bank’s focus here is going to be on your experience delivering similar projects, your capacity to fund cost overruns and your character.

If your project fits within a Bank’s requirements, we have relationships with many highly regarded and experienced quantity surveyors, builders and valuers who we can put you in touch with to ensure you have the best development team possible.

Near-Bank Lenders

Near Bank lenders are the mid-market lenders that have a price point on development lending of around 9%-12%. Although seemingly more expensive than Banks when comparing interest rates, their lending parameters can be less stringent by way of equity requirements. Near Bank lenders have a limitation on the size of projects they deal with, some may not be able to finance projects that are over $5 - $10M.

LCR – Near banks focus more on the LVR on a project as opposed to LCR. The value of a project is determined by an ‘On Complete’ valuation of the project. Their target will be somewhere between a 60 – 70% LVR lend. This usually translates to a 75 – 85% LCR (depending on the profitability). They often may limit their LVR, however, to require a good level of equity (15%+).

Development Margin – Near Banks target a development margin of 20%+, however they will allow some developments to fall under this if your other metrics are sound.

Exit – This is either the pre-sales or investment proposition mentioned previously. In the current environment the target for near banks is between 25 - 75% of debt cover for pre-sales (i.e. $0.25 - $0.75 of NET sales for each $1.00 of debt). For Investment type facilities, the lenders will need some assurance around LVR on completion and likelihood of tenancy.

Development Team – Near banks are more flexible on this with who you use – they will require all the parties I have mentioned previously above but won’t be so picky on who you are to choose.

Non-Bank Lenders

Non-bank lenders tend to have the least stringent lending parameters based on the metrics of your development. They are often a good choice if you are new to the game and are tight on equity. Because of this and the increased risk to the lender, their price points are slightly higher, at around 12%-15%.

LCR – Non-Banks also tend to focus more on the LVR on a project as opposed to LCR. Their target will be somewhere between a 70 – 80% LVR lend. This usually translates to an 80 – 100% LCR (depending on profitability). They also may limit their LVR however to require a level of equity in (10%+), however, can look to fund up to 100% of the total cost. In the situations that they fund 100% of cost the overall metrics of the development are VERY strong (i.e. fully pre-sold, big profit margin and strong project team).

Development Margin – Non-Banks target a development margin of 20%+ however will allow developments to fall under this. This is to allow for the higher cost of funding that can erode those margins, making things tight.

Exit – Non-Banks will go ahead without any pre-sales on most developments. If you do get sales, as above, it might mean you can push them on loan amounts, however, there generally isn’t a requirement for them. If you are starting out on your development journey, it’s generally advisable to pre-sell your properties to provide certainty around debt repayment and the overall risk of the project.

Development Team – Non-Banks are more flexible on this with who you use – most often they will require all the parties above but won’t be so picky on people. Some Non-Banks however will proceed without parties like a QS or Valuer which could save you up to $50k on a project. This reduction of cost can help mitigate the higher interest rates.

Have more questions?

Although very much a brief summary of development finance, I hope this has given you a basic understanding of what it might take to get your development off the ground and funded. Development is often perceived as an arduous process with many hoops to jump through, particularly if you are just getting started – but that is where we can assist. If you have a project in mind please don’t hesitate to get in touch, we would love to chat.

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