Property development is a complex process that demands strategic planning, careful risk management, and access to the right funding solutions at every stage. The funding cycle typically consists of four key phases: Pre-Purchase, Consenting, Settlement, and Development. Each phase comes with its own unique challenges and funding considerations. Here, we break down the critical stages of a project and their funding requirements.
(1) Pre-Purchase
During the early stages of a project, most costs are funded through cash equity. At this point, there’s no security to obtain external funding (such as a mortgage), and the risks associated with the project are higher. This stage is about validating the assumptions in your feasibility study.
Your equity should cover two critical areas:
- Due Diligence: This includes liaising with planners on bulk and location studies or consulting engineers about a site’s infrastructure limitations. Many developers hesitate to spend money on due diligence before going unconditional on a property, but it’s often the best investment you can make. Spending a few thousand dollars upfront to avoid a bad project is a win.
- Deposit Payment: When declaring the contract unconditional, the agreed deposit—usually 10% of the purchase price—must be paid. This is almost always funded by the developer’s own equity.
(2) Consenting
Consenting typically begins immediately after the contract goes unconditional. Like other pre-development milestones, these costs are generally funded by the developer. Note, these expenses are still considered by funders (along with other consultant costs) when calculating the project’s loan-to-cost ratio at the development stage.
Timing is Key: Aim to complete as much of the consenting process as possible before settling the property. The process can take up to nine months, depending on the complexity of the project and council requirements.
Deferred Settlement Advantage: Securing deferred settlement terms can be highly beneficial. This allows the vendor to carry the financing costs while you navigate the consenting process, reducing the financial strain on your end.
(3) Settlement of Property
The settlement phase is a significant milestone and often the first point where external funding is triggered. Developers typically adopt one of two strategies:
- Maximising Leverage: Inject minimal equity into the land settlement to preserve capital for other project needs, such as initial enabling works.
- Reducing Funding Costs: Inject maximum equity (cash) into the land settlement, ensuring the development funder will finance the project (including enabling works) as part of their facility.
Land Settlement Funding: Loan-to-Value Ratios (LVRs) for development land are typically around 60%, reflecting the higher risk compared to completed properties. One of the reasons for this is because land values are particularly sensitive to market fluctuations; for instance, a 10% drop in house prices can result in a 30% decrease in land value.
Strategic Lending Decisions: Low-cost funders, such as banks or “near-bank” lenders, are often used for the land settlement if the site is not consented or shovel-ready. However, if deferred settlement terms are close to the commencement of work, developers may settle directly into a development facility, establishing an early strategic partnership with a development lender and ensuring a smoother project transition.
Development Phase
The development phase involves the largest equity injections, making it the most critical stage of the project. Developers who inject significant equity during settlement often find development funding easier to secure. Those relying on high-leverage land facilities may face additional hurdles, such as:
- Debt Reduction: Re-settling into a development facility by reducing existing debt.
- Completing Enabling Works: Reducing the cost-to-complete by finishing initial works, such as ground preparation or drainage.
How Should Equity Be Injected?
As a lender, it’s our preference to fund 100% of the cost-to-complete, reducing any existing lending to unlock the development loan facility. This gives us transparency over how the construction phase of the project is to be funded (and paid for).
However, a development facility might include a refinancing of an existing loan and a cost-to-complete facility that assumes some initial work has already been done. This approach shortens the development program and minimises the period non-bank funding is required; however, it can catch developers out if funding is not obtained in time for the next stage of the project.
Ultimately, the best solution depends on the developer’s experience and ability to manage the project.
What If More Leverage is Needed?
While there’s no substitute for cash equity, the following strategies can help stretch your resources:
- Securing Pre-Sales: Pre-sales validate the project’s price point and provide lenders with a clear exit strategy. This can increase willingness to offer better terms.
- Validating High-Risk Cost Items: Completing initial groundworks or other risky tasks upfront can provide lenders with greater confidence.
- Releasing Value Early: Obtaining freehold titles early can allow you to restructure debt and kick-start portions of the project.
- Staging the Project: Breaking the project into stages reduces overall funding requirements and aligns with traditional funding metrics over time.
Conclusion
The property development funding cycle involves navigating multiple stages, each with unique challenges and requirements. From pre-purchase to project completion, developers must carefully balance equity injection, risk management, and lender expectations. Strategic decisions at each stage can significantly impact the project’s viability and profitability. By understanding the intricacies of the funding cycle and partnering with the right financial institutions, developers can position themselves for success in a competitive market.
For more info, reach out to our Lending Team.