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October 28, 2016

Is finance frustrating your deal?

Securing debt finance is a big part of property development. And that, of course, means dealing with those bloody banks.

My typical development consists of two to four dwellings, so to keep things simple I generally opt for residential lending. With this form of lending, banks don’t require a feasibility study or a proven track record in development, and interest rates and fees are typically lower than those available through commercial lending.

Purchasing the Ivanhoe site with an investment loan, we simply had to stump up 20 per cent of the purchase price plus stamp duty and legal fees, and demonstrate a capacity to service the loan.

Planning costs (fees to town planner, draftsman, arborist, draftsman, engineer, council, etc.) and holding costs had to be paid out of our own pocket.

Once our planning permit was attained, and working drawings, specifications, and building contract were in place, we asked the bank to arrange a valuation of the completed project, in order to determine how much further debt finance we could get based on a minimum 20-per-cent LVR (loan-to-value ratio).

Mind you, it’s at this point I always consider selling off-market. In Melbourne, good sites with good plans are hard to come by, and developers – particularly those who are also builders – are often willing to pay a decent premium for shovel-ready projects. Half the profits in half the time can sometimes make sense.

For townhouse developments in Melbourne, subdivision typically happens after construction is completed. As a result, banks apply a discount to the end valuation in order to protect themselves against having to sell all properties on a single title part-way through construction (e.g. four units on separate titles are worth 10 to 20 per cent more than four units on one title).

Depending on the valuation and construction costs, you may need to tip in a bit more cash in order to maintain a 20-per-cent LVR and avoid lender insurance fees. However, if you purchase well, design smart and negotiate a solid fixed-price building contract, you can often have the bank fund 100 per cent of construction.

I’ve known a lot of people who’ve wanted to get into development but can’t get their heads around the finance.

The reality is, you don’t need a million dollars, and you don’t need to be making hundreds of thousands each year. If you can afford to purchase an investment property, and to pay professionals to help you attain good planning permissions, then you can get into property development.

Sure, you may not be able to finance construction 12 months from now, once permits are in place (the bloody banks change the goal posts so often, it’s hard for most of us to know), but at least you’re giving it a go and learning first-hand. With smart advice, you should be able to achieve six-figure profits with only permits anyway.

Our Ivanhoe project is proceeding but has suffered some minor delays due to headaches with a neighbour, council, a builder and, of course, the bloody banks.

One final piece of advice… find a good mortgage broker.

About Andrew Stone

Andrew Stone is a director at Property Analytics, a real estate data analytics consultancy and licensed buyers’ agency. He regularly manages JV townhouse developments with family members, mates and clients.