Property Development 101 – Part 7

So, you want to be a property developer!

Property development can be a great way to make money, if you know what you are doing. The property development process can be a long and complex one, from finding a site and selecting the builder to financing the deal and building and selling. Property development can lead to significant profits but it can also lead to significant losses so the more you have planned and thought about your project, the more likely you are to succeed. Remember the old saying, “A failure to plan is just a plan to fail”.

This “Property Development 101” series won’t be able to teach you everything there is to know about property development. However, if you read each instalment, you will learn about the fundamentals of property development and it will make you aware of what questions you need to ask so that you can make educated and informed decisions.

In this “Property Development 101” series, I will be outlining the major steps involved in property development. These include:

Setting your goals

Research

How to find development sites

~Novel Serialisation: Heavens Fire~

Choosing the best site

Drawings

Feasibility studies

Working with council

Selecting a builder

Finance

Project management

Real estate agent/property manager

Tax

In the first instalment I outlined some strategies in relation to goal setting and research.

In the second instalment I detailed some methods on searching for development sites and then some considerations when selecting the best site to develop.

In the third instalment I provided an insight in to the design and drawings for a development.

In the fourth instalment I looked at one of the most critical components of property development, the feasibility study.

In the fifth instalment, I outlined what to do when working with your local council or shire so as to obtain approval for your development.

In the sixth instalment, I addressed a number of issues you need to consider when selecting a builder for your project.

In Part 7 of the Property Development 101 series, I look at finance and how development is different to financing a long-term investment property.

Overview

Property development finance can be quite different to borrowing for an established investment property. The deposit required can be much greater if you wish to develop. The interest rate charged can also be higher, depending on a number of factors. Much of this will depend on the bank’s perceived risk of you, your project and your timing.

Risk

In a typical investment loan scenario, the bank will look mainly at your risk and the risk in the property.

Your risk will be determined by a number of factors which are commonly referred to as “The Five Cs of Credit”. These include character, capacity, capital, collateral and conditions.

Character – have you defaulted on a loan before; have you been bankrupt?

Capacity – based on your salary and other income, do you have the capacity to make the repayments?

Capital – how much deposit will you provide? The more money you put in, the less risk the bank takes.

Collateral – what assets do you have to secure the loan?

Conditions – why are you borrowing the money? The bank will typically lend you more money if you are buying an established property than if you plan to build property.

When you are borrowing to develop, the bank also takes into consideration the property cycle. They are not too concerned about this when borrowing money to finance an established investment property that you plan to hold for the long term. This is because you’ll most likely rent it out and the property may go through a number of property cycles. However, as I have mentioned before, timing is critical when developing property to sell. You (and the bank) don’t want to be building when the market is soft and is forecast to be even softer when it is time to sell the new properties.

Deposit

There are many lenders who will provide up to 90% of the value of an established property if it is for investment purposes. This means you only need a 10% deposit plus purchasing fees. When it comes to developing, the deposit required can be much higher. How the bank perceives your risk and the risk of the project will determine whether you need a 20% to 30% deposit. Simply put, you will need more of your own money up front if you wish to develop property.

Interest Rate

If you go to a bank or mortgage broker, it won’t be difficult to get a loan with an interest rate below 5%. Development finance can be quite different. If you’re buying land to build two dwellings, you might be able to borrow money at just over 5%. If you plan to build four or more, it is often considered a commercial loan and your interest rate can jump to almost 7%.

Other Considerations

If you are planning to develop properties and keep them to rent, the bank will look at your ability to service the loan based on your personal income and the projected rent. If you plan to sell the new dwellings, the bank may lend you money but only if you have pre-sold some of the dwellings. The bank may not require pre-sales if you are building just a couple of dwellings but if you are building many units (generally four or more), this will certainly be the case.

In this article I have only touched on some of the major considerations when borrowing money to develop property. If you plan to develop, you should spend some serious time with your bank or mortgage broker to discuss all that is involved in property development finance.

Written by Peter Koulizos – lecturer and author – www.thepropertyprofessor.com.au