Don’t Wait for RBA to Save You Money and Onerous Pre-Sale Hurdles

Don’t Wait for RBA to Save You Money and Onerous Pre-Sale Hurdles

“Debt is the lifeblood of sustainable property development.”
Market conditions since 2009 have created a difficult environment for developers (particularly of development projects) as the majority of lenders have tightened pre sale hurdles and loan to value ratio (LVR) covenants.
The success of a construction project will depend on a number of key components, including:
The lead time to commencement of construction (holding costs)
The entry price into the land
Total project cost
The capability of the developer, the builder and the quality of development management and project management
The product being built having a suitable price point for the location of the project
If these components are not finely tuned then the risk of project failure is greatly increased.
Many lenders (particularly the major banks) have tightened their pre-sale hurdles to a minimum of 75% debt cover and in some cases 100% debt cover. This means that the developer has to undertake a lengthy marketing period and pre sell a large proportion of the product before construction commences and this leads to increased holding costs (interest). These increased holding costs have the potential to undermine the fundamentals of a successful project, especially if the debt level on the land is at maximum levels.
Many lenders have also tightened their LVR covenant which then requires a greater proportion of equity from the developer.
Too many times it would seem that developers focus on the interest rate, rather than the key components mentioned above. In a construction project, interest is typically capitalised into the loan. Interest therefore accumulates at a faster rate in the latter stages of the project.
By focussing on the interest rate, the developer will be bound up in meeting onerous pre sale hurdles when a better alternative is available in accepting a loan offer at a higher interest rate with more favourable pre sale hurdles and LVR covenants. This will enable the construction to commence much earlier.
In this instance the higher quantum of capitalised interest will be offset by reduced holding costs and the potential of higher sales revenue as a smaller percentage of product is pre sold at a discount.
Many experienced developers ignore holding costs, or not aware of all the costs associated with holding the property. It usually “works out” for them because there is usually enough profit to absorb these holding costs in most cases.
The waiting time adds to “holding costs” and the delay in commencing the project can actually eat away any benefit of the lower interest rate offer. So in the end, it may well be more advantageous to accept a funding offer at a higher interest rate as opposed to holding on.
Our advice when looking for a construction loan is to do your research. There are also many lenders aside from the major banks, which are offering very low interest rates. If you do your research, you will find a suitable construction loan that has a low interest rate, without sacrificing all the benefits that you are entitled to.