Top 10 Effective Finance Options For Your Next Property Development Project

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Updated: February 16, 2022

How to finance your real estate development project? - Top 10 Options

One of the most significant parts of property development is obtaining equity and right finance options for a project. Due to the high development expense, few people can afford to fund a project independently. To finance a development project, you need to think creatively and laterally.

Property developers have traditionally invested very little of their own money in their projects' long-term or permanent financing. They give the initial funding or deposit, which is renewed with additional funding sources as the project progresses.

Property developers are entrepreneurs; they are the ones who have the vision and the ideas, but they aren't always the ones who put the money in. Instead of money, these entrepreneurs contribute a project's concept, time, effort, skill, and knowledge. As a result, almost all property development projects require financing. Earlier, I have already discussed my secret of becoming a property developer with no money. Today, I came with the top 10 real estate financing options to provide the required funding for your next property development project. 

The ability of financial institutions to lend is determined by the number of deposits received and the rate at which outstanding mortgages are repaid. With the merger of several banks almost in every country, many new banks have emerged. Building societies are becoming banks, industry retirement funds providing loans, and insurance firms entering the mortgage market. Because loans have become more accessible due to the increased competition, consumers have benefited greatly.

Ways-To-Select-The-Right-Finance-Option-Or-Your-Property

Crucial Factors That Affects Real Estate Finance

The following variables should be considered when determining whether or not to proceed with development from a financial standpoint:

  • Inflation
  • Interest rates 
  • The status of the economy (timing) the flow of the money supply 
  • The difference between the Reserve Bank's prime interest rate and the inflation rate is the actual interest rate.

As I always said, an increase in interest rates usually results in an increase in capitalisation rates, which leads to a decrease in market prices. This has a particularly negative impact on commercial property. It becomes more viable for a developer to enter the property market when rentals increase faster than building costs. 

Borrowers are often confused by the variety of real estate loan options available and the intense marketing campaigns lending organisations use. As a result, when weighing the options available, the borrower must evaluate the interest rate and the establishment fees, annual administration fees, early repayment penalties, and the cost of refinancing arrangements if necessary. 

You can ensure that you get the most significant financial package for your development project by shopping around.

You must make sure that your real estate funding options are appropriate for the project you're working on; for example, you shouldn't use short-term financing to fund a long-term project. This is a crucial component in the development's final success.

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How does financing work? 

Before approaching a lender, make sure you know what kind of real estate financing you need by examining the following factors:

  • Short-term loans are usually only provided for three years. Long-term finance is typically issued for periods of more than seven years, whereas medium-term finance is typically offered for periods of three to seven years.
  • Which financial institutions are involved in the type of development you're proposing? (for example, commercial banks or insurance companies).
  • The primary funding sources for the project (for example, mortgage bonds or bridging loans) and what gearing options are available to boost the development's return.
  • Whether or not there are any other options for funding (for example, joint venture, syndications or trusts).

When it comes to policy and practises, lending institutions vary greatly. While lender A may not even consider one type of proposal, lender B may approve the same development. 

Your success will be determined by your knowledge of the policies, methods, and procedures of various lending institutions, as well as the numerous possibilities available in the finance business.

Raising Finance Cost

Aside from the developer's equity (deposit) required for a loan, there are several other costs to consider - most of which are negotiable. These are the following:

  • Banks' fees and costs include loan application fees, appraisal expenses, mortgage insurance, and legal fees.
  • Stamp duty, registration costs, conveyancing fees, settlement fees, shire inquiry fees, water inquiry fees, land tax, and disbursements are all examples of government expenses.
  • A raising fee (if applicable) is a fee of about 2% that is frequently paid when money is in short supply.

What are the options for financing your real estate development project? 

Property developers can borrow money from a variety of financial institutions. Below are 10 alternatives to finance real estate projects.

Finance options

1. Commercial banks

Commercial banks specialise in mostly short-term commercial credit, focusing on liquidity than savings, and their appraisals are more conservative. The overdraft facility is one of the most common forms of short-term financing; nonetheless, several banks have gotten more involved in property financing through various subsidiaries.

If I talk about Australia, the National Australia Bank (NAB), the Commonwealth Bank of Australia (CBA), Westpac Banking Corporation, and the Australia and New Zealand Banking Group are prominent commercial banks in Australia.

2. General or savings banks

Depositors are the primary source of funding for general banks. General banks operate and participate in property finance the same way as building societies did previously. Building societies' amount of house loans has decreased in recent years. As a response, many of these societies have converted to banks and expanded their offerings to include insurance, consulting services, and commercial lending.

General banks handle the majority of residential property mortgages and suburban development.

3. Merchant banks

These individuals or institutions act as underwriters or agents for corporations, providing securities, investing advice, and facilitating corporate mergers and restructuring. Merchant banks are often also called investment banks.

Essentially, merchant banks borrow money on the wholesale market and lend it to businesses and industries but not to the general people. Merchant banks can provide bridging and permanent capital finance for property development; however, they primarily focus on office and larger shopping centre projects.

4. Building Societies

Building societies operate similarly to banks, with most of their funding coming from consumer deposits. These clients are building society members. 'Mutual societies' is a term used to describe building societies.

There is little difference between a building society, a credit union, and a bank from a regulatory standpoint. Several building societies have amalgamated and diversified into health and travel insurance and business financing due to competition and a lower proportion of the house mortgage industry. Building societies do not have a set limit and will advance up to 90% of the property's value. The interest rates charged by building societies are equal to those charged by most banks.

5. Credit unions

Credit unions are co-operatives owned and governed by the individuals who use their services. Each union member is both a shareholder and a client. Members' deposits are used to fund loans to other members.

6. Companies that provide life insurance

These institutions are primarily interested in long-term investments with growth and capital appreciation. They are not interested in minor development initiatives because they receive substantial cash flows from contracted depositors (their policyholders).

Insurance companies, on the whole, prefer to invest in completed developments by other developers at a predetermined price with guaranteed profits. Some more giant corporations have subsidiaries that will finance projects and then sell them to the parent corporation once completed.

7. Superannuation funds

Superannuation funds are comparable to life insurance firms in terms of significant, reliable cash flows. These funds are typically invested in long-term real estate ventures that are profitable, stable, and potential to rise in value.

Some superannuation funds are bound by the trust deed (a legal document that lays out the trust's rules and procedures) and may be limited to investing no more than 5% of the fund's value in any single project.

8. Property trusts and unit trust companies

Property and unit trust businesses differ from managed fund operators, who deal primarily with stock portfolios and do not participate directly in the real estate market. Some unit trust businesses, such as property managed fund equities, solely invest in shares of property and construction companies listed on the stock exchange. These unit trusts have a portfolio of shares from various property development companies.

9. Syndications

Syndications provide private investors access to high-quality properties through property syndication memberships that combine the most pleasing aspects of property ownership with lower risk.

The risk of investing in property syndication is higher than investing in a property trust, for example, because the purchaser will only own a single property rather than a portfolio of properties.

You can invest through various legal forms such as partnerships, incorporated joint ventures, or a unit trust structure. The syndicate typically has a 5- to 10-year tenure. After which, the property is sold, and the net proceeds are distributed to the investors.

The following are the two types of syndicates:

Syndications

Private syndicates

In this type of syndication, a small group of people, such as friends or business associates, band together to buy and develop real estate.

Public syndicates

Most public offers will necessitate preparing and filing a prospectus or information memorandum with ASIC by the promoter/developer or management. The prospectus contains thorough information on the syndicate, development/risks investments, and potential rewards. Licensed securities dealers, property managers, financial advisors, and accountants may market the syndicate to the general public.

To be a successful developer, you must understand risk management in property development

10. Brokers or finance companies for Right Finance Options

Finance businesses are more likely to lend money to new developments than provide long-term ownership, but one can negotiate this. When working with loan providers, keep an eye out for interest rates that are 1.5 to 3.5% higher than the variable rate. It's a good idea to search around before taking out a loan from a financing business.

With the wide availability of funding packages, it takes time to shop around for the ideal package to fit your development needs. As a result, many brokerage firms have sprung up to help consumers.

These brokers serve as mediators, connecting borrowers with lenders. The financial broker's job is to find the most appropriate loan for the borrower. While the brokering service is usually free, there may be a nominal cost, and the broker will usually receive a commission from the lender they propose. However, be wary of brokers who favour specific lenders because they give them a higher commission.

The number of financial institutions and brokers is limitless, and they range in size from tiny to enormous. If you're dealing with a broker, make sure they're licenced.

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What are the methods of raising finance? 

Below are the six most effective methods of raising finance -

What-Are-The-Methods-Of-Raising-Finance

1. Mortgage bond

A mortgage bond is an endorsement on a property's title deed stating that the property is being held as security for a debt owed by the property's owner. Any creditor can request a mortgage on a debtor's fixed property. This means that when a person takes out a loan from a financial institution, a mortgage is recorded on the property's title deed.

The documentation that comes with a mortgage bond application spells out the rights and responsibilities of the mortgagor and mortgagee and the creditor's protection against the debtor transferring the property before the loan is fully paid off. 

Without the first mortgage holder's permission, you cannot secure a second or third mortgage bond against the property.

There are two different kinds of mortgages accessible. They are as follows:

  1. a bond that pays both capital and interest.
  2. a fixed or interest-only loan. Here, only interest is paid, and the capital is settled at a specific period.

2. Bridging finance

Bridging finance is a more complex and riskier financing technique than the previous method; hence it is more expensive. The two types of bridging finance are as follows:

  1. Speculative or short-term development financing
  2. Long-term development finance. 

The nature of these two types of development finance necessitates that financial institutions use various funding approaches, namely: 

1. Short-term developments are typically speculative; the developer buys the property, constructs the structure, and then sells it as strata title, group housing, time-share, or similar to institutions such as insurance companies. 

When this financing is employed, a raising fee of 2 to 6% is usually imposed, paid in advance. The charge supports the institution's administrative costs for evaluating the project and finance application. 

Institutions often may waive the raising charge to secure the business, depending on how volatile the property market is. In some cases, the institution will take an equity stake in the development to gain more influence over the project. The so-called trade bill or bill of exchange is another critical source of short-term finance. This is simply a post-dated check that the vendor writes in his name to sign. The buyer formally accepts the bill by signing it.

2. Different types of finance are required for long-term improvements. In this situation, the developer typically approaches the financier to obtain a long-term loan that short-term lenders cannot provide. 

The financier extensively reviews the application regarding market conditions, future growth trends and patterns, economic viability analysis, precise drawings, and the applicant's creditworthiness before granting the mortgage. When it comes to granting finance, the quality of presentation and depth of the material to the financing institution can make a big difference.

3. Debentures

When high-profile corporations need money for expansion, they issue debentures to raise the funds they need. Debentures, in simple terms, are fixed-interest securities sold to members of the public who purchase them based on the viability of the proposed development. In effect, the public funds the corporation (or invests in it) in exchange for a medium- to long-term income yield.

A trust deed typically governs debentures, and a trust or merchant bank represents the debenture holders. When interest or principal payments are not made, charges are assessed against the company's assets.

You can redeem the loan's capital in the following ways:

  • By making annual part-payments
  • At a predetermined time
  • There is also the option of not redeeming the capital.

A firm may authorise several debenture issues. Debentures issued after the initial offering are ordered in preference order. These investments are typically predicated on fixed interest rates, making them unappealing to investors during periods of rising inflation.

Debentures

Short-term debentures

In bridging finance, short-term debentures are sometimes utilised. Government stock rates and interest rates are inextricably linked. Debentures are frequently convertible into shares, giving investors the following options:

  • Changing the loan into stock or a fixed-term loan allows for capital appreciation if the company grows.
  • If profits aren't realised, you can continue with the loan.

The commodity is more liquid and frequently more accessible to sell than an entire structure, advantageous for holding debentures. Debentures can also be made freely transferrable without regard to time limits.

Although a corporation does not have to be listed on a stock exchange to issue debentures, it can still be managed by state regulations. Some organisations must also facilitate the sale and acquisition of debentures. Merchant banks and trust corporations frequently aid in purchasing and selling debentures.

4. Shares

When a firm decides to 'list' or 'float,' its shares are frequently sold on the stock exchange. This is especially true of huge syndicates with a wide range of interests and is too big to raise money from their members. A corporation doesn't need to list on the stock exchange to issue shares, though larger companies frequently do so.

Share prices of publicly traded firms fluctuate in response to market factors, both to the investor's benefit and, more often, to his detriment.

5. Leaseback(incorporating sale and leaseback)

In commercial and industrial property developments, leaseback is a prevalent method of financing employed chiefly by insurance companies and retirement funds.

The sale and leaseback mechanism entails the owner or developer selling a building to an institution and agreeing to lease the structure back on a defined lease payment schedule.

The lessee's financial stability mainly determines the risk. When a corporation seeks a sale and leaseback deal, it usually signals to experience financial troubles.

The majority of leases are between 15 and 20 years long. Taxes and insurance are not included in the lease payments to the lessor. The lease payments are set out such that the investor may pay for the building while still making a profit.

The investor and lessee agreement will most likely allow the lessee to either repurchase the building or renew the lease arrangement after a specified period has passed.

This clause is in the lease agreement to protect the lessee, although most investors prefer to delete it. Only the interest parts of mortgage payments are tax-deductible, whereas lease payments are entirely deductible.

Modern sale and leaseback arrangements, particularly for new developments, include seller guarantees about rental income, leased areas, maximum expenditure, and, in many cases, an agreed minimum return. Should any variables change to an unacceptable level, you may adjust the development's purchase price. In most cases, the developer's guarantees are valid for the first five years of the developed property's operation.

With new developments, the developer will often take a three- to five-year head lease (the main lease taken by an individual or institution who then sublets to a third party) over the property, ensuring a return for the investor. According to the lease agreement's agreed percentage, the surplus is split between the investor and the developer if the expected returns are higher than predicted.

With a head lease in place, the investor is guaranteed a particular return on the development for a set length of time (albeit possibly lower than market-related rates). As a result, the developer will sell the development at a more significant profit margin.

6. Joint-venture partnerships For Finance Options

A joint venture agreement is an alternative method of financing a development project. Lenders are often unwilling to lend money at low rates, but they may be prepared to partner with the developer in a joint venture. Depending on the project, these joint ventures might take several forms. Some lenders may form a partnership and pay the land acquisition and the development costs in exchange for a share of the profits. Other lenders may purchase the land and enter into a contract with the developer for his services, receiving a portion of the possible profits. In either case, the developer has been given a chance to put his talents to work with other people's money.

How does a lender evaluate a loan? 

Because the cost of funds determines interest rates, the lender will examine the cost of funds and determine a reasonable profit margin. The profit margin is determined by the investment's risk, the length of time these funds will be outstanding, and the payback plan. A rate decrease may be considered if the developer is a repeat customer with an excellent track record.

How-Does-A-Lender-Evaluate-A-Loan

The rate of interest

Because the cost of funds determines interest rates, the lender will examine the cost of funds and determine a reasonable profit margin. The profit margin is determined by the investment's risk, the length of time these funds will be outstanding, and the payback plan. A rate decrease may be considered if the developer is a repeat customer with an excellent track record.

Charges for loans

Aside from the interest rate, the lender will charge the developer a fee for arranging the funds and an annual service fee. Scrutinise these fees, as the various fees offset some of the low-interest rates advertised initially. It's also worth noting that new facilities are frequently charged a price.

Term of the loan

Unless the developer specifies otherwise, the lender will set the borrower's time to repay the loan. The period will be determined by various factors, including the type of development and entity that the developer is employing.

Guarantees of funds

Most lenders will require full or partial guarantees or sureties on loan and the property's equity to be developed. You should make every effort to keep these financial guarantees to a minimum.

Many developers have lost their riches due to personal guarantees on failing projects. Finding substitute or extra guarantors is one way to minimise guarantees; however, this strategy may require the developer to share ownership of the project.

Alternatively, the developer could raise the development's equity or deposit and guarantee the outstanding loan sum.

How to select the best financial deal for your real estate project? 

Because there are so many financing organisations competing for your business, you should shop around for the most excellent financial deal for your development project. 

The first stage would be to compile a list of potential lenders who are willing and able to provide the development with the appropriate loan. If you establish an industrial facility, approaching a house mortgage lender is fruitless because the lending firm may not have policies or guidelines for financing commercial operations.

After you've scoured the market for possible financing, carefully examine not only the group that offers the lowest interest rate but also the terms and conditions that apply to such a loan. Keep in mind that the lowest loan isn't always the best in the long run.

Complete the relevant application paperwork, submit it with your feasibility study, and determine which institution you will contact. Inform the lending officer that you are considering other options. 

As I previously stated, your feasibility study is a critical document that must be well-presented and researched, as the lending officer will not be the one to grant the necessary approval. This could be the duty of a board of directors or committee you have never met and to whom you have not had the opportunity to show your development in person.

How-To-Select-The-Best-Financial-Deal-For-Your-Real-Estate-Project

Negotiation 

If your loan is approved by the finest two or three institutions, research and analyse each loan offer, as each institution is unique. Request a written confirmation and commitment once you've decided which offer is the best.

Some lenders may need a non-refundable commitment fee to be paid after the loan is approved. You should seek a copy at this point so that your lawyer may evaluate the materials. When determining your obligations, you and your lawyer should exercise extreme caution.

Most property development finance documents are written in the lender's favour, and many sections are non-negotiable, but a developer can seek benefits by rewording them. These provisions are more commonly negotiated in commercial deals than in home loans.

When considering your loan, consider all of your possibilities and think outside the box. There are a variety of loan refinancing options available to match your needs.

Is it true that each party to a loan transaction has their own set of criteria? Each can achieve its goals with good, creative thinking. It's important to remember that lenders are in the business of making money, which they accomplish by lending money. As a result, if one proposal does not meet your needs, look for another that will. Your accountant or attorney may be able to help you with this.

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Bottom Line

The developer must know how to discover possible lenders, present the financing plan, negotiate, and finalise the loan to find and secure property development finance.

It would be best always to try to deal with multiple lenders when looking for the appropriate loan. Always locate several potential lending institutions and evaluate them carefully. Even if the loan officer tells you that your application appears acceptable, the loan terms alter dramatically when the loan committee approves the loan. Because time is of the essence, bargaining with multiple lenders may be advantageous. 

Additionally, ensure that your loan proposal is accurate and that all pertinent information is included when submitting it. This will shorten the time it takes to process your loan application and boost your chances of getting it approved.

It is the right time to take advantage of the property development feasibility suite. Get ready to flip, develop, and control your property profits. 

FAQs

How does property development finance work?

Traditional mortgages are not the same as development funding. Lenders often examine the property's valuation before making a loan decision based on it and the borrower's eligibility. When making development loans, lenders examine the property's expected worth once the development project completes.

What are the sources of finance for real estate development?

Lending in the mainstream (which is the banks). Lending from the private sector (It's when you team up with someone who recognises the worth in your project and strikes a contract with them.).

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