Tag: capitalised interest

Navigating New Zealand’s Property Development Landscape in 2024

As 2024 unfolds, the New Zealand property market is a confluence of challenges and opportunities for developers. The mix of data presents a complex picture, making it difficult to discern a clear market direction. This update aims to distil key facts, offering insights to navigate the shifting sands of the property development sector.

A Surge in House Price Expectations

A notable rebound in housing confidence signals rising expectations for house price increases, especially in Auckland. This trend, captured in the ASB housing confidence report for the three months leading to January 2024, hints at a broader national optimism. It suggests we might be on the cusp of recovery and growth, moving away from the recent downturn.

Listings Reach All-time High

February 2024 witnessed an unprecedented surge in new listings, with Realestate.co.nz reporting a 45% year-on-year increase to 11,788 new residential listings. Auckland’s market saw a significant influx, marking an 11-year high with 5,382 properties listed with Barfoot and Thompson. This abundance puts buyers firmly in the driver’s seat, heralding a shift towards a buyers’ market despite underlying positive pricing trends.

The Interest Rate Conundrum

Interest rates remain a pivotal area of focus, with mixed expectations about their future trajectory. While there’s apprehension about potential hikes, there’s also a growing sentiment that we might be nearing the peak. This uncertain interest rate landscape requires developers to engage in strategic financial planning more than ever. With mortgage advisors and agents noting an increase in first-home buyers with pre-approvals, a moderate interest rate scenario could spur a notable uptick in market activity.

Economic Indicators and Market Activity

The economic backdrop has its complexities, with Stats NZ indicating a recession in the latter half of last year. Despite this, the housing market displays resilience, with early 2024 showing healthy year-on-year house price growth. This dynamism points to a stabilising market, ripe for growth against the backdrop of increasing population and persistent housing shortages.

Regional Dynamics: A Diverse Story

The recovery narrative is not uniform across New Zealand. Regions like Otago exhibit strong housing value increases, contrasting with areas experiencing different median sale price trends. This diversity underscores the importance of nuanced strategies for developers, tailored to specific local market conditions.

New Consents Decline

The end of 2023 saw a sharp drop in new home consents, although this follows a period of record highs. This fluctuation suggests a normalisation of the consenting environment rather than a downturn. The true impact of new consents on the market remains to be seen, serving more as an indicator of developer optimism than a direct measure of upcoming construction activity.

Refined Strategic Considerations for Developers

Given the mixed signals from the property market in 2024, developers must navigate cautiously, armed with strategies that address current trends and anticipate future shifts. Here’s how these strategies can be tailored to the unique landscape described:

Navigating a Buyers’ Market with Flexible Sales Strategies

With listings at an all-time high and buyers in the driving seat, developers should consider flexible pricing and sales strategies to stand out in a crowded market. This might include offering purchase incentives, customizable new build options, or flexible financing arrangements to entice discerning buyers.

Capitalizing on the Surge in House Price Expectations

Despite the broader buyers’ market, areas like Auckland are seeing a surge in house price expectations. Developers in these regions could prioritize projects that align with this optimism, focusing on properties that cater to market segments demonstrating the most robust growth prospects.

Adjusting to the Interest Rate Landscape

With the potential for interest rate stabilization, developers should remain vigilant and prepare for various financial scenarios. This includes securing favorable loan terms now, while also staying prepared for any shifts that could affect buyer affordability and, consequently, demand for new developments. Maintaining a good relationship with your non-bank lender may afford you more flexibility should the need arise.

 Economic Recession vs. Market Resilience

The apparent disconnect between the broader economy’s performance and the housing market’s resilience suggests developers need a dual focus. They should not only track macroeconomic indicators but also deeply understand the housing market’s unique dynamics, adjusting project timelines and investment focuses accordingly.

Responding to Changes in New Consents

Following a peak, the drop in new consents indicates a potential normalization of the market. Developers should use this period to reassess their project pipelines, prioritizing developments that meet current market needs while also preparing for future demand rebounds.

Addressing the GDP Per Capita Decline

Understanding the impact of a falling GDP per person on market segments is critical. Developers might need to pivot towards more affordable housing projects or adjust their offerings to remain appealing to a potentially cost-sensitive buyer base.

Targeting Untapped Regional Markets

With regions like Otago showing strong growth, developers should consider expanding their focus beyond traditionally popular areas. Detailed market research can identify other regions with high growth potential, allowing for diversified investment and reduced risk.

Emphasizing Quality and Value in Development Projects

In a market characterised by an abundance of options for buyers, emphasising the quality and unique value propositions of your developments can help differentiate them. This includes focusing on sustainable building practices, innovative design, and community integration that adds tangible value to potential buyers.

Forward-Looking Strategy

As 2024 continues to unfold, developers face a complex environment shaped by economic uncertainties, shifting buyer dynamics, and regional disparities. By adopting a forward-looking strategy that addresses these nuances, developers can confidently navigate the current landscape. Staying adaptable, informed, and responsive to market changes will be key to seizing opportunities and overcoming challenges in New Zealand’s property development sector. 

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Capitalised Interest Loans in Development Finance

Capitalised Interest Loans

In the dynamic realm of development finance, capitalised interest loans serve as a strategic option for lenders and developers alike, offering flexibility to the client and risk mitigation for the lender. Let’s delve into the core features of capitalised interest loans and understand why it is the preferred repayment type in the world of development finance.

Understanding Capitalised Interest Loans

Monthly Interest, Capitalised: Capitalised interest loans break away from the traditional repayment model. Instead of developers managing monthly interest expenses, the interest is ‘capitalised’ onto the principal amount each month. The entire repayment, covering both principal and accumulated interest, happens when the loan matures.

Assessment of exit strategy: When a capitalised interest repayment structure is adopted, the lender relies on the client’s ability to “exit” or repay the loan in full upon maturity to earn their interest (and recover the principal sum). In this sense, development funders place a greater emphasis on “exit strategy” as opposed to “cash flow” when a cap interest structure is adopted. In most instances, this will be the eventual sale of the properties upon the projects completion. However it could also be by way of refinance to another lender. Understanding the dynamics of loan repayment structures is essential for both lenders and developers. 

Risk Mitigation: A loan facility is comprised of a principal sum, and capitalised interest provision. If a capitalised interest repayment structure is being used:

• The lender retains the capitalised interest within their facility. Doing so means that the lender knows what their total exposure (LVR) will be upon maturity of the loan.

• A loan facility is made up of multiple components. Assuming that the Facility Limit of a loan is fixed, allowing for capitalised interest within the loan facility will reduce the principal sum available to the client.

The Dynamics of Development Loans in New Zealand

Cost-to-Complete Basis: In New Zealand, property developments are predominantly funded on a cost-to-complete basis. This means that the lenders structure loans to ensure that they always have sufficient funds in their loan facility to complete the project. As a project progresses, the property value is enhanced and the “cost to complete” the project decreases. This creates a surplus within the loan facility, allowing lenders to release funds to the client, recognising the value contributed to the site.

Capitalised Interest as a Project Cost: Finance costs, an integral part of any project budget; thus “interest” needs to be retained by the lender within their loan facility. Strict adoption of funding on a cost-to-complete basis will see most lenders insist on interest being capitalised for property developments. Lenders will forecast what they expect the likely interest cost will be for the term of the loan and include a provision within the loan facility.

Loan term and final LVR position: Lenders providing a capitalised interest loan do so for a specific term and based on a forecast facility limit. When the end of the term is reached, the loan will reach the facility limit. If a loan extension is required, further capitalised interest (and fees) will need to be provided. This means that the facility limit will need to increase. However, doing so will increase the LVR. If the lender is unwilling to take on further risk, the borrower will need to pre-pay interest and fees for the extended term. This is one of the reasons why lenders pay very careful attention to the development program when setting up the loan facility and during the construction phase. Potential delays can ultimately increase finance costs and increase the LVR for the loan.

Tailored Solutions for Property Developers

Development Income: Property developers, often without traditional income streams, rely on project completion and sale. Capitalised interest loans align with this income structure, allowing developers to defer interest payments until the project is sold, simplifying their financial commitments, and alleviating the financial burdens during critical construction and development phases.

Minimising Capitalised Interest Expense: Unlike lender fees, which apply to the facility limit, interest is only charged on the drawn balance of the loan. To reduce interest expenses, consider minimising the initial cash advance. This may involve paying off existing mortgages or restructuring debt away from the development asset, ensuring an unencumbered property before setting up the loan. However, it’s essential to acknowledge the trade-off – reducing debt may cut costs but could impact the return on equity for the project. 

Capitalised Interest Loans: A Win-Win for Property Developers and Lenders

In the diverse landscape of development finance, capitalised interest loans emerge as the preferred repayment method for lenders and property developers. These development loans empower developers to prioritize cash flows toward projects while concurrently serving as an effective risk management tool for lenders.