Start construction on your next big investment with a residential property development loan.
A small residential development like a duplex or townhouse offers the potential to maximise the investment profits available from one block of land. However, if you need to borrow funds to finance your next residential property development, finding the right loan can be a tricky and sometimes complicated ordeal.
Let’s take a closer look at how to choose a property development loan and get started on your next project.
What is a property development loan?
A property development loan is a loan designed to fund the construction of multiple properties on one title. For developments of up to four units, such as duplexes, triplexes and townhouses, funding is available from residential property development loans; if you’re planning on building a larger project you will need a commercial property development loan.
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.
Small developments of four units or less will typically qualify for residential lending, which should make the loan application process much simpler. 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 loan is classed as commercial, you can expect to pay a higher interest rate than you would on a residential loan for property development. You will also have to contend with a different fee structure than applies to residential loans. 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.
This article will focus on residential property development loans for developments of four units or less.
How do residential property development loans work?
Residential property development loans are structured in much the same way as residential construction loans. This means that rather than being released as one upfront sum, the funds for your development will be released at the end of each building stage.
Funds are usually released at the following stages:
- The deposit
- Base stage
- Frame stage
- Lock-up stage
- Fixing stage
Any remaining balance is then released at the completion of the project. This loan structure ensures that you are able to continue paying your builder at each stage of the construction project.
What are the features of residential property development loans?
Because developments of two, three and even four units can be classed as residential, they’re seen as a low-risk proposition when compared with large commercial developments. As a result, the banks impose less strict lending criteria on these types of loans.
Some of the features of residential property development loans in Australia are:
- Up to 80% LVR. The maximum amount you can borrow varies depending on the size of the project and the lender you choose. You can typically borrow up to 80% LVR for two-dwelling projects and 70% LVR for larger developments but it’s worth shopping around with the help of a mortgage broker to assess the LVR limits of different lenders.
- Higher interest rates than normal investment loans. The interest rate on a residential development loan in Australia is normally 1–2% higher than the interest rate on an ordinary investment loan you would take out to buy an existing property. However, the rates on residential development loans are lower than those offered on commercial development loans.
- Contingency funds. Some (but not all) lenders will require you to have contingency funds in place in case something goes wrong during the construction process. For example, if you’re an owner-builder the lender may ask you to provide evidence of contingency funds worth 10–20% of the loan amount, so if the project is delayed or exceeds cost expectations you will be able to cover any funding shortfall.
- Hard costs only. Residential development loans typically only cover what are known as “hard” costs, which are basically the labour and materials associated with the construction of the development. So-called “soft” costs, including DA approval, land clearing, legal fees and architects, aren’t covered by your loan. Make sure you factor these extra expenses into your calculations when working out the total cost of your development.
Things to consider about residential property development loans
Keep the following factors in mind when choosing a loan to fund your residential property development:
- Find funding first. Before you get started on any residential development, it’s vital to work out how much you are allowed to borrow. Once you know how much the banks are willing to lend you and you have a clearer idea of how you will manage all costs associated with the development, you can start searching for the right loan.
- Consider your strategy. Make sure you have a clear reason as to why you are developing: Do you want to sell all of the properties? Do you want to live in one and rent out the rest? Do you want to retain ownership of all properties but rent them all out to provide ongoing income? This will help you work out where to buy land and the type of development you want to build.
- Complex application process. There’s much more involved in applying for an Australian property development loan than there is in applying for an ordinary home or investment loan. Not only will the lender want to assess your own financial standing and history but they’ll also need to consider the viability of the development.
How to apply for a residential property development loan
The bank needs to assess two main factors before approving your development loan application: your development plans and your financial situation.
Before lending money for a development, the bank will want to know whether your planned project is viable and potentially profitable. To prove that it is, you will need to put together a property development business plan. This should include:
- The money you have to put towards the project
- Contingency funds to cover costs if unexpected expenses arise
- Your development experience on similar projects
- The builder’s experience and qualifications
- A description of the property, including where it is located and its zoning
- A design concept for the project
- A timeline for construction
- The total projected cost of the project
- Your plan for what to do with the properties upon completion, such as how you plan to sell the properties
This is an important document and needs to be as detailed and professional as possible. If necessary, you may want to enlist the services of a specialist firm to help you put together a property development business plan.
The lender will also need details of your financial situation, such as:
- Your overall financial position, including assets and liabilities
- The security you can provide for the loan (this could be cash or equity in an existing property)
- Your credit history
You will generally need to provide recent payslips, bank statements and group certificates to verify your income. This will allow the bank to work out how much you can reasonably afford to borrow and repay.