With banks still coy about lending on development, I thought I would post some of the major reasons that we see for development deals being declined and some tips to avoiding these pitfalls.
Reason 1 – Not Enough Capital
It is important to be aware of how much capital will be required to complete your project. As a general rule, lenders will only lend on maximum of 80% of the total costs of the project. As a general rule, they will only be leveraged to a maximum 60-65% of the land value as well, so the contribution will normally be needed upfront.
How to Avoid:
Do a thorough feasibility prior to proceeding with a project and ensure that you have sufficient funds to complete the project based on 80% funding of total costs. Make sure you factor in capitalised interest (at least 12 months) into your calculations. If you are using a money partner, make sure you have the funds available in a trust account before proceeding. We have seen a number of deals fall over due to money partners pulling out at the last minute.
Reason 2 – Not Enough Pre-Sales
Banks will these days require at least 80% of the debt covered by pre-sales, which means the combined sale price of pre-sold property should equal at least 80% of the total loan amount. Often the bank will require 100% debt coverage. Some non-bank lenders will be able to finance a development with less or even no pre-sales, but these are only on certain transactions.
How to Avoid:
Make sure you are aware of the number of pre-sales you require and that you have researched the market properly so you are confident the properties in your development will sell off-the-plan. If your development is not suited to pre-sales, ensure that you are able to arrange finance without pre-sales or with a lower pre-sale requirement through a non-bank before proceeding.
Reason 3 – Constructing Before Finance is in Place
This is a no-no for development lenders, and most will shy away from partially completed developments. Lenders like to have control over the funding for the development from the beginning and if they do agree to fund a partially completed development, they will only advance against land value, so it may involve a sizeable equity contribution before obtaining approval.
How to Avoid:
Wait until finance is in place before beginning construction. Builders will often be in a hurry to start, but if possible, hold them off at least until you know the bank will be ready for the first draw down.
Reason 4 – Not Enough Experience
Developer risk is a key element in assessing a development finance transaction and a major factor in developer risk will be your experience with other similar developments.
How to Avoid:
If you are attempting your first development, start small and manageable. If you have done previous developments, but none approaching the scale of your current development, it may be worth partnering with an experienced developer or employing an experienced project manager to oversee you development.
Reason 5 – Problems with Builder
Builder risk is another element that is assessed and lenders will conduct some due diligence on the builder. The level of due diligence will depend on the size of the project and will range from a builder’s resume of past projects to obtaining the builder’s financials.
How to Avoid:
Ensure your builder has conducted similar projects to yours in the past successfully and if possible drive past these developments yourself. Make sure your builder has all the correct licensing and is of a scale that will be able to handle your development.
Reason 6 – Problems with Valuations
Low valuations are a common factor that can stop finance applications going through. Particularly in the past two years, valuers have tended to be extremely conservative when estimating the end value. Development loans are assessed on both cost and the end values, so if a project has too small a margin it will be shied away from by lenders.
How to Avoid:
Ensure you are conservative when you do your feasibility projections. Research your market well and obtain comparable sales in your area. Communicate with the valuer and assist with obtaining comparable sales and any other information that they may need to conduct their valuation.
Reason 7 – Too Much Other Debt
Regardless if a project itself stacks up in any other area, lenders will still look to ensure that you are able to service your other debts. A common issue we come across is with developers who begin a new development prior to selling down stock sufficiently to pay off existing debt. This can be an issue, as developers often don’t have a strong income outside their developments from which to show servicing.
How to Avoid:
Make sure your previous development are complete prior to starting a new development, unless you have a considerable amount of capital available. Maintain moderate LVR’s where possible, or if you are not strong balance sheet wise, partner with someone who is.
I hope these tips are useful. If you have any queries with regards to development funding, please don’t hesitate to call our office on (03) 9662 1999.
