Things to Consider Before Financing a Property
Disclaimer: The author of this blog piece does not work for Hamilton Wood & Company and is not associated with Hamilton Wood & Company in any way. The facts and information contained herein may differ in the UK.
Organising finance is a key prerequisite to starting a real estate development project.
What do you need the finance for, who could be the lenders, what will be the cost implications; these are some of the prime questions that you need to address to plan for projects financing.
For a property developer, it is critical to understand the finances surrounding the project being developed.
And when it comes to accessing finance for any new property development, it is of course, important to first seek to understand what the financial institutions will look for when approaching them for financial assistance.
A financial institution is never going to sanction a loan to an applicant unless it sees concrete proof that the money will be returned to them along with interest accrued on the same, at the end of the loan tenure.
If this financial assessment does not turn out in the developer’s favor, it will not be possible to convince that particular lender to lend you the finances you need unless they have complete faith in your ability to repay sum, plus interest borrowed.
For this reason, any lender acting as a responsible lender would seek to understand your ability to repay the loan, plus interest, whilst also making assurances that loan repayments wouldn’t be to the detriment of your personal circumstance crippling you under their weight.
Lenders would try to gauge the individual merit of the project itself before deciding whether the project and individual are good prospects for a loan.
Therefore, if you are planning on asking a bank to lend you money, they are not going to be satisfied simply with the security of the upcoming project, but also your past track record for repaying any money borrowed.
Unless the bank or lender believes in you as an individual, your current circumstance or financial status, your business plan and the competency of your team then they will air on the side of caution and restrict access to the finance you need.
One way to allay any fears a possible lender could have is by having a meeting with them to go through a detailed presentation of your aspirations, and your plan, and also to discuss your circumstances in an open-forum.
The presentation should be a general overview of the project and an assessment of its financial viability, both in the short and long-term.
Therefore, your loan application should not be just about putting forth the idea, but also a firm and thorough assessment of any contingencies to safeguard the investment of the lender should it be granted. Remember, they want assurances the loan, plus interest will be repaid. If you can’t satisfy this basic requirement, then no funds will be issued to you or your project.
Any property development loan is structured in such a way that the lender will provide access to funds based on a percentage of the project known as loan to value ratio and the percentage of the loan will differ based on your status and ability to repay. In most cases Loan to Value is up to 80% but can be more or less again based on your circumstances.
Financial institutes are less stringent about lending in projects that are of the residential type.
They classify these as class 2 or 3 unit projects. Developers can obtain an LVR of almost 80-70 % depending on the size and nature of the project.
To ensure the loan comes through, of course, the developer would have to contribute a significant share of their own equity into the project.
Developmental loans offer staged payments which are released at the end of every building phase, as follows:
- Base stage
- Frame stage
- Lock-up stage
- Fixing stage
The balance is supplied once the project meets completion.
Project development finance has a striking difference with respect to ordinary investment finance.
Project development finance allows you to account for the interest that will be levied on your loan when you apply for the loan.
This way, the loan interest is financed for to ensure project take-off.
In other words, the interest is already considered as a part of the amount you owe to the lender each month, and interest is charged on the original sum plus the interest.
Developers usually start the repayments when they start selling the project.
To retain ownership of the development, the borrower has to pay the entire loan amount, plus interest that the lender issued to them.
Applying for a long-term investment loan usually allows investors to refinance the property by the time all portions of it are sold on the open market.
Not many financial institutions are going to sanction a loan that is more than 80% of the developmental cost, and you need to prove to them that you are solvent enough to repay the loans or that the developer will have sufficient cash-flow to cover all financial liabilities.
Types of Project Finance Loans
A real estate project may require finance at various stages, and the types of loans may also differ in terms of the nature of the activity itself:
- An acquisition loan or developmental loan that covers the purchase, development application, pre-construction expenses, etc.
- A construction loan.
- An investment loan to help refinance your property.
On paper, Banks remain the biggest source of funding for real estate developers however they are often more stringent in the way they consider whether they will lend money or not, and certainly, after the global financial crash from 2008 to roughly around 2014 they certainly appear to have ‘tightened their belts.’
They prefer lending to developers who have a strong track-record however, considering that banks put real estate development in the high-risk category, a developer has to follow stringent processes to hit the ground running and to strengthen the project’s chance of success.
This scenario has resulted in private financers, joint venture funders and the likes to become growing favourites amongst the property developer community when it comes to seeking a lending source that is viable and makes commercial sense.
For projects with high financing needs, lenders usually ask the borrowing firm to assure some form of pre-sale activity that minimises the risk of the development.
Therefore, the real estate developer has the requirement to unload a portion of their development project into the buyers market as a mandate, and sometimes the requirement can be up to 50% of the project to be sold in pre-sales.
These funds cannot be further invested back into the developmental procedure; they have to be held in trust to prove the viability of the loan you have asked for from the financial institute.
Project Progress Report
Financial institutions demand ongoing feedback that shows how your project is progressing.
Proof of cash flows and budgetary measures and controls are required to be provided before and during the duration of development.
In short, the following documentation is required to be shown to the lender to secure the loan:
- A fixed price contract for the building.
- A quantity surveyor report or in layman’s terms a detailed list of costings for the construction of the project from your builder.
- Cash to the value of 10% of the purchase price is required as evidence of pre-sales.
- In the course of the project development, the following reports are required as well:
- Progress report from the builder.
- Reports from the project manager.
- Cash flow reports and financial projection reports.
- Information regarding timeline challenges.
- Changes in the feasibility of any part of the project plan.
- Sales reports.
Project financiers always verify before releasing the loan amount whether the portion of the project they are lending you money for, is completed or not.
Sometimes proof of payment to suppliers and vendors are verified by the lender to ensure they are paid for so that there is no redundancy in dues.
Financial institutions usually send a valuer agent to assess the project, or they may ask for a certification from independent consultants.
Here are some of the keynotes concerning the lender’s verification:
- Lenders assess the development of the project for a number of reasons. Such as fire-sale price of the security. Such as, what would be the value should the have to possess the project and mortgage it.
- The end value of the dwellings in the building should not be higher than the median price of the locality. Otherwise, they perceive it as low-quality security, due to difficulties in sales.
- They check the zoning of your security in the respective Master Plan. Lands that fall under residential zones are the easiest to sell.
- The postcode. If your postcode reflects strong capital growth owing to a large population, the banks will take it as an incentive to sell.
- Banks prefer to lend to residential real estate compared to commercial estates like hotels, resorts or serviced apartments.
These are amongst some of the prime considerations that a real estate developer needs to consider to secure project funding irrespective of the source.
As a general rule of thumb, providing you can assess your requirements now, and for the future and also plan for any changes in your circumstances should the worst happen, this will stand you in good stead when trying to secure property development finance.
The author of this blog piece does not work for Hamilton Wood & Company and is not associated to Hamilton Wood & Company in any way. The facts and information contained herin may differ in the UK.
Girish Bindal is the Head of Content at PropTiger.com, Makaan.com & Housing.com.
He draws from more than a decade of cross-industry experience and has worked for brands in the Real Estate, Recruitment and Consulting domain.
In his current capacity, Girish is recognised for his ability to distil current news, numbers and opinion to deliver content that benefits from his experience in industry.
With an analyst’s approach and a sharp focus on numbers, Girish has been organically progressing www.PropTiger.com to build a growing audience around the globe. An audience of individuals who are keen to buy property.