Development Finance


Unlike most other forms of commercial finance, development finance is rarely assessed on loan serviceability, but rather loan clearance. i.e. the part or full sale of the developed property.

 

Borrowers are rarely expected to service the loan. In fact, in most cases the interest is capitalised for the term of the project and simply makes up part of the project cost. Interest is not treated as an ongoing commitment which needs to be met by income, but a bulk cost which needs to be recovered by the sale of the asset. This is probably the most important part to consider when speaking to clients. The capitalised interest amount needs to be considered as a real cost when assessing the total amount of finance required.

 

Main points to consider and ascertain from clients.

  1. Total Cost of the development – including capitalised interest/Contingency allowance/GST.
  2. Development Feasibility and Project Cash Flow Budget.
  3. End Value (generally needs to exceed costs by 15 to 20%).
  4. Developer history/background.
  5. Builder history/background.
  6. Debt Clearance – what is the strategy to sell off completed units? Most likely lenders will require some level of pre-sales.
  7. Owner’s contribution. This will vary depending on all of the above, but 20% is generally considered standard.
  8. Details of other completed developments by the client. Were they completed on time? Were they profitable?
 

Typical Scenario – Development Finance


Developer wishes to purchase land and develop 20 apartments, which he expects to sell for approx $460,000 per apartment.
 
Land Purchase: $1,000,000
Construction Costs $5,000,000
Interest Costs: $700,000
Other Costs (architects, permits, marketing etc) $300,000
Contingency Costs: $300,000
Total Costs: $7,300,000
Expected end value: $9,200,000


The amount the lender will provide will vary depending on the development and also the asset backing and experience of the developer.

Generally speaking it will be a maximum of 80% of costs and 70% of end value (the lower of). In this case that would be $5,840,000.

NB: You may also have to take into account “in one line value”. This is a reduced value based on fire sale prices. This could reduce end value by as much as 20%.


How much of the development will be required to be pre -sold will vary also depending on the above factors, including location, marketability and also the lender. In volatile markets, lenders are less likely to take comfort from future values and will almost certainly want a large portion (if not all) of the debt covered by Pre-Sales.