Need to find financing to fund a property development? Here’s everything you need to know to find the right loan.
Development finance is an area of confusion for many Australian borrowers. If you’re looking for funding to finance the cost of a property development, do you need a residential investment loan or will you need to move into the commercial lending sphere? How much money can you borrow and what sort of documentation will you need to provide regarding the development in order to get your loan application approved?
The answers to these questions depend on the size and scope of the project.
Residential or commercial?
One of the key issues to contend with when obtaining a loan for a property development is whether or not you will need a residential or commercial loan. However, whether the funding is arranged as commercial or residential lending depends on the number of properties being built.
Felicity Heffernan, mortgage broker, CEO of Property Loan Advisor and the author of the soon-to-be-published book Extraordinary Property Investing, says that a development of up to a few units will be classed as residential. “The major lenders will consider the deal up to an LVR (loan to valuation ratio) of 90%,” she says.
“Once you get beyond small developments it will definitely be commercial and becomes a lot more complex.”
Brad McDonnell, finance expert for JDL Strategies, explains that a lot of the finance requirements will depend on the size of the project being undertaken. “Smaller units can be covered under residential investment, where some lenders will cover up to four units on one title, with anything larger than that generally requiring a commercial lending application,” he says. “The major banks will only offer two or three [properties] while Bankwest, for example, will allow clients to build up to four on the same title, provided the LVR is at 80% or less.”
The residential and commercial lending sectors differ quite substantially in a number of ways, from loan features and fees to the documentation required to apply for a loan. With this in mind, it’s worth taking a closer look at the features of residential and commercial loans for property development separately.
Residential lending for property development
Small developments of four units or less will typically qualify for residential lending, which should make the loan application process much simpler. “Basically the lending criteria is a residential qualifying type of loan and is similar to a land and construction loan, i.e. the value of the land plus the building tender from a licensed builder,” Heffernan says.
“There are no pre-sale requirements – the bank considers the units as residential investment – the qualifying would be done as if all three units were to be held and rented out and not relying on a sale to bring serviceability into line.”
The normal income verification needs to be done and you will be able to include the rental potential of the properties when proving your ability to service the loan. You’ll also need to have sufficient deposit saved, with most LVR limits set at 80% but some as high as 90% available.
“Loans for property development are generally full-feature loans (once progress payments are completed) so long as the LVR is acceptable to the bank, with interest-only available, as well as offset accounts if it is covered under the residential lending policy,” McDonnell adds. “LVR is generally calculated on the end position, with a valuation completed on an ‘as if complete’ basis.”
The interest rate on a residential loan will also be lower than the rates available on commercial loans, while standard loan application fees apply. During the application process for a residential investment loan you will also need to include the usual building plans, council approval, builder’s insurance and other paperwork to ensure your application is processed as quickly as possible.
Commercial lending for property development
If your property development project is for any more than three or four units, it will fall into the commercial lending category. This will have a significant impact on the paperwork you need to provide to access funding, and also affect the loan features you are able to access.
“If the application falls into commercial lending, the LVR is generally lowered to 70%, with top-up security from other property held also being used if required/available,” McDonnell says.
If the loan is classed as commercial, you can expect to pay a higher interest rate than you would on a residential loan for property development. “Commercial lenders may also add in a risk margin, depending on the size and scale of the project etc,” McDonnell says.
You will also have to contend with a different fee structure than applies to residential loans. “Residential lending will only have the standard bank application fees whereas commercial lending will have fees that are usually charged as a percentage of the loan amount, and could vary between 0.50% and 1.50% depending on the strength of the application,” McDonnell explains.
Banks take a much more conservative approach to commercial lending, which means you’ll need to provide a range of details and extra information in addition to meeting the standard criteria that apply to a residential loan. These include:
- The applicant’s experience managing properties. The lender will want details of your development experience, including the address, project details, cost to build and profits.
- The builder’s reputation. The lender will need information about the builder to be used for the project, and if you’re planning a large-scale development the builder will need to be on the lender’s panel.
- Full project details. You will need to provide building plans, DA approval and a building contract.
- Evidence of pre-sales of the properties to be developed. McDonnell says this will most likely be required for large-scale commercial loan applications, “particularly if the LVR or loan amount is increasing”.
“If the client is looking to hold the property once construction is finished, the bank will also do analysis on the rental market,” McDonnell says. “Some lenders have specialised bankers to assess property development applications, while a loan size of over $1 million will generally see a commercial application leave the SME space and have a dedicated Business Banking Manager see the application through.”
Applying for property development finance
Property development is a complex and high-risk investment option, so it’s not recommended for first-time investors or those with little property experience. Instead, Heffernan says development is best suited to sophisticated investors. “The knowledge and skill set required is well above, say, a mum-and-dad investor with an owner-occupied property and an investment property,” she explains.
Heffernan recommends that beginners “practice” the necessary skills and develop knowledge by renovating an investment property. This allows you to learn how to budget effectively and to deal with builders and banks, all of which are essential to a successful development. From there, aspiring property developers can progress through to duplexes and small developments of three to four units to hone their skills.
“I encourage clients to put together a proposal to present to the lenders so that we can get a quote that specifies the costs and LVR and what pre-sales will be required,” Heffernan says. This will include everything from the loan amount required to the ‘as is’ value of the property, your development experience, full project details, the building contract, the ‘on completion’ value of the properties, and whether you plan to sell or retain the property.
If you put in the time and effort needed to put together a comprehensive proposal – getting help from a mortgage broker is definitely recommended – your chances of getting the right loan with the best possible interest rate will significantly increase.