What is construction finance? It’s a reasonable question, but unfortunately, applications can throw up some unreasonable answers from banks and traditional construction finance companies for many developers and constructors. Developers are supposed to have access to practical, start-to-finish funding solutions.
Yet, construction finance in Australia often raises more problems for developers than it solves.
Many issues occur around equity requirements. Many construction finance companies are inflexible regarding how much your project is worth, concentrating more on the present than the potential. It can be massively frustrating for builders and developers. Often, a project will be ready to roll and promises significant profits, but the sticking point is funding.
At Agility, we believe that workable construction finance loans need to be a good fit for experienced developers with various advantages and challenges. Not only that but when different projects have varying strengths and potentials, adequate construction finance should be tailored to suit – minimizing headaches for developers and constructors and maximizing gains.
Projects are all unique. Developers and builders bring many different skills and concerns to the table – and standard, limited bank funding options can’t quickly produce optimal results. In this article, we’ll examine the broader question, what is construction finance? However, we’ll approach that by reviewing a commonly asked question for many developers – what’s the best way to utilize the uplift in land value resulting from a DA?
Applying for a DA: Using the resulting uplift in value.
You’ll likely have applied for many different construction finance loans from various providers as a seasoned developer. If that’s the case, you’ll have experienced more than your fair share of frustrations.
Unfortunately, construction finance in Australia can throw up some odd requirements that seem counterproductive when attempting to turn over a good profit. Beyond expected downsides like construction finance interest, developers and builders also cope with somewhat antiquated lenders who sometimes take a confusing project evaluation approach.
One problem you may have already experienced revolves around equity contribution and banks or traditional construction finance companies that refuse to acknowledge an uplift in value once your DA is in place.
It’s an exhausting old story for many developers out there. They identify a profitable development opportunity and purchase the land before embarking on a sometimes years-long process to get an appropriate DA in place.
What follows is hardly rocket science for developers, but bankers don’t seem willing or able to get their head around it. Several things occur between buying a block of land and your DA being granted. The first is that the value of your land has increased significantly over time. The second is that a successful DA application has made the ground even more attractive to potential buyers, increasing the value.
There’s nothing unusual going on here. After all, the DA pushes that lucrative project nearer to completion. So, any loan officer at a bank is likely to appreciate that, right? I mean, it’s just common sense.
Well, no, and yes.
Traditional construction finance companies and banks use a relatively rigid method to evaluate construction projects. It’s called TDC, or total development costs. When the project is all set, developers or builders approach a bank, which is when the problems begin. If they get approved for construction finance in Australia, they’ll also get hit with substantial equity contribution requirements.
Construction finance loans in Australia: What is TDC?
At this point, it’s helpful to determine how the bank arrived at its construction finance loan offer. Banks and traditional construction finance companies consider several different elements and group them all up into the total cost of development (TDC).
- The purchase cost of your land
- Construction loan interest
- Any applicable land holding fees
- Local council rates
- Construction costs
- Project management
- Real estate agent fees
- Marketing costs
With a TDC-based valuation, any upturn in land value resulting from a successful DA application is ignored to put a construction finance package together.
Construction finance in Australia: Banks and TDC
It seems a great shame. Banks and traditional construction finance companies are essentially ignoring existing equity. The fact is, that also influences how much equity contribution you’ll be expected to make. Let’s see what that can do to a typical project. Agility recently helped a client who planned to undertake a subdivision project in a residential suburb of Melbourne. They purchased a sizeable block of land and spent two years obtaining a DA with permission to build two luxury townhouses on the site.
Then, they approached the bank.
The bank evaluated the project based on its TDC. In this particular case, that equated to $2 million. The purchase cost for the land made up $1 million of that. There were no apparent issues with construction proceedings, and the developer had a good track record on similar projects extending back for a decade. The bank put a package together based on TDC and specified some additional conditions.
- The builder would need to achieve 50% pre-sales, meaning they would need to sell one townhouse off-the-plan.
- The bank would then fund 80% of TDC, so the developer would also be required to offer a 20% deposit
- During construction, the bank agreed to release funds according to construction phases. 15% would be advanced upon completion of site clearance, and a further 25% upon completion of groundworks and slabs. Then the remaining 20% payments would be made after framing, lock-up, and project completion.
- Between each construction phase, the bank would require a site inspection, and further funds would only be released after its completion.
Private Mortgage Managers: Gross realization value
With contractors at the ready, a DA in place, and a healthy market for luxury townhouses in that suburb, the client was understandably keen to start work. Agility evaluated the same project, but we could apply a different method as a private mortgage manager.
The primary difference between Agility and the bank was that we assessed the project based on its gross realization value (GRV). We looked at the costs, the builder, and everything else the bank considered, but we also took the end value of the project into account – and we examined the difference in land value after the DA.
In this case, that uptick was anything other than modest. A GRV-based assessment allowed us to put considerably lower requirements on the developer, reducing their equity contribution requirements significantly.
Here’s how that worked:
- TDC amounted to $2 million, with the original purchase cost for the land amounting to $1 million.
- With the DA for the project in place and the two years between purchase and the developer is ready to go, the land was worth $1.3 million.
- That left the developer with a TDC shortfall of just $700,000.
- The gross realization value of the project equated to two luxury townhouses, each worth $1.5 million. A total of $3 million.
- Using a GRV-based evaluation, Agility was able to source a cost-effective construction finance loan for the entire project, with zero requirements for pre-sales.
Private Mortgage Managers Vs. Traditional Construction Finance Companies and Banks
The benefits for our Melbourne client didn’t stop there. Throughout the project, the construction finance loan minimized delays and maximized ROI for the developer in several different ways:
The developer got the project started and finished more quickly.
The construction finance loan came with no requirement for pre-sales. That meant the builder could get workers and materials on-site without the need for time-consuming marketing activities – which they commenced when the project was further along. Potential buyers had more to look at. It also resulted in the first phase of construction being completed in record time and each subsequent phase staying ahead of schedule right up to the end of the project. At that point, the developer accelerated marketing efforts significantly and exploited the high specification of the townhouses. The tactic produced a markedly higher return than the builder had experienced in the past when forced to sell off the plan.
The developer exited the project more smoothly.
Construction finance companies and less-than-ideal loan structures don’t always help builders exit projects and begin new ones. It’s not just about using the equity resulting from a DA. Construction loans are based solely on TDC, and once houses, offices, or apartments are completed, using the resulting equity to fund a new project is nigh on impossible. It goes even further than that.
Banks won’t just be interested in helping you move from one development to the next – they’ll expect you to repay construction finance loans on time, even if that means selling the stock for less than it’s worth. Because private mortgage managers like Agility can base construction finance loans on GRV, it typically means the opposite. In the case of our Melbourne client, we helped them unlock the value tied up in their stock to facilitate not only a smooth project exit but all the time they needed to get the best possible price for the luxury townhouses.
The developer had fewer avoidable delays during the build.
Part of the reason the builder stayed ahead of schedule during the build went beyond achieving a quick start. Without the need for time-consuming inspections after each construction phase, work could progress unhindered. Because Agility could see the end value in the project and the builder’s equity contribution burden got further reduced by the upturn in value from the delay, funds were always available, and workers were on-site strictly when required. It contributed to a more cost-effective construction finance loan and a more significant ROI.
Flexible construction finance in Australia
Banks and traditional construction finance companies can hinder the efficiency of your project, and unsuitable construction finance loans can severely compromise your ROI.
Private mortgage managers like Agility operate differently. Our approach is more builder-friendly and exploits strengths in your project. When that happens, developers and constructors get access to more cost-effective, fit-for-purpose construction finance loans – and tasks get completed faster with fewer hassles.
At Agility, we believe an Australian construction finance loan should make more sense for constructors and developers and address your everyday concerns and challenges. Our expertise allows us to identify the best solution for you – and your project.