Opportunity: Costs No Pre-Sales
Before you commence any development project or investment, it is obviously important to initially determine how much you can borrow and how you will be able to manage all associated costs of the development. The Australian economy has seen many of the major players really tighten their lending criteria. Most banks are only interested to lend to experienced developers.
Development finance is so much different to any traditional investment finance. At usual terms, you can borrow the ongoing interest as part of your finance package. This means you do not pay interest during the construction phase of your project, but the interest is capitalised. In other words, the interest is added to the amount you owe at the end of each month and the next month you pay interest on the interest.
Hence, the significance of pre-sales contracts versus a backdrop of changing market conditions and property values have created a difficult environment for developers, particularly with development financing. Generally your development loan is structured, so that lenders provide up to 70% to 80 % of the cost of the project, rather than its end value. They will expect you, as the developer, or your equity partners, to provide sufficient equity.
Pre-sales are in most cases required by the lender to reduce risk for a property development. For some developers, it provides much needed certainty that they will sell their housing inventory upon completion. For the lender, it is essential for the repayment of the construction loan.
Presales can be achieved in many ways. Find buyers yourself with direct marketing. Local agents can market your real estate development. It can also be obtained through project developers in real estate who specialise in selling property off the plan. Financial planners providing real estate investments to their clients are another source. Builders may have marketing services for their product and achieve sales for you.
Conflicting views on enforcing pre-sales contracts have focused on non compliance with consumer legislation. In Queensland, the legislative framework on presale contracts provided a number of termination arguments for buyers to choose from. Recent steps to reduce complexity and remove technical grounds for overturning presales contracts in Queensland are welcomed to reduce red tape.
New development projects face considerable thresholds, well higher than the pre-global financial crisis requirements. Uncertainty about future property asset values upon completion, high pre-sale requirement and higher debt cover ratios were linked to the difficult lending environment.
Pre-sales remain a key factor for project development financing, but recent trends have raised scepticism about its value, if litigation is the only option for enforcement. Lending institutions are likewise keener to assess your project management workforce. Your professional team who will create your development finance presentation will be your ticket to a good reputation with the lending institutions. It is therefore important to create a highly professional feasibility study to show that you are ready to face any contingency.
According to the Reserve Bank of Australia (RBA), accessing funding for new residential developments continues to be a problem for small development players. This however lessened the certainty that they will be able to meet their presales targets. The RBA Governor said, “While finance is available to households on relatively favourable terms, some developers continue to report difficulties in obtaining finance for new construction, with banks requiring a higher proportion of pre-sales than was typical prior to the global financial crisis”.
BIS Shrapnel noted most of developers and purchasers decided to remain on the sidelines in an uncertain economic climate in the past year. “The uncertain economic environment continues to place financing constraints on developers, with high levels of pre-commitments still necessary to secure funding in many instances”, BIS Shrapnel indicated in its report.
“Whilst this is less evident for the larger developers who are able to borrow on a corporate basis as opposed to a project-by-project basis or even finance their projects in-house, speculative development by smaller developers has been much harder hit,” added BIS Shrapnel.
The big banks have taken over as financiers of residential developments after the withdrawal of non-banks and foreign lenders, due to the high cost and high risk of funding property developments. In addition to banks’ presales requirement, property developers are also being asked to provide multimillion-dollar deposits ranging from 20% to 30% of the development cost.
Borrowing costs remain high amid the volatile economic environment and tougher regulatory requirements under Basel II, and even tighter requirements under future Basel III rules. Banks will release funding at 200 to 300 basis points, above the prevailing cash rate. They are holding cash of approximately $110 billion, on which they are making “little or no margin”.
Analysing it, the cost of development funding will be much higher if the banks will not be able to lend out. Banks are clever to have the backup liquidity, sitting there, earning nothing, just to ensure that they can continue to lend more.
Could your next project benefit from some expert development finance? Get in touch.
For expert advice:
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Sydney NSW 2000
P / 02 8916 6246
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Melbourne VIC 3000
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