Every residential developer knows that the two most difficult parts of a project are securing funding and keeping expenditure under budget.
In 2022, with a construction sector racked by frighteningly strong headwinds, that first challenge – financing – is harder than ever. Delivering a project is no longer a sure bet, and banks aren’t as willing to put up funding, even with meticulously realised feasibility studies. Applying isn’t simple, either. The loan approval process can delay a project for months, which impact delivery timeframes and potentially put completion at risk.
So, for ambitious residential developers without long track records, the question is now: how can I secure funding without the trouble of going to a bank?
The Problem With Bank Loans
Borrowing from banks presents two key challenges for developers:
- The approval rates. Following COVID and construction sector turmoil, banks are typically less willing to finance higher-risk projects. This means up-and-coming developers may be facing financing difficulties right off the bat.
- Pre-sales. Often, pre-sales are a necessary evil to secure funding, but they can impact on project profitability (and come with their own inherent risks).
The ABS’s January numbers show a massive 27.9% decline in dwelling building approvals, higher even than October 2021’s 12.9% drop; there’s also been a 2.5% increase in building costs in the December quarter and 78% YoY drop in apartment asset transactions.
That’s bad news for residential developers looking for financing. Approval rates for small business loans generally are sitting at 14.5%% and 20.3% for big and small banks respectively – about half their pre-COVID levels.
Similarly, although most bank and non-bank lenders require pre-sales, delays in funding acquisition and construction (as well as market fluctuations) can see project profitability nosedive. This can even occur if the project stays on track – upfront discounts on presale prices can chew up profits too.
Private Lending for Commercial Developers
So, if approval rates and pre-sales are two big hurdles developers face with bank funding, how can going to a non-bank lender help?
The answer is simple: non-bank lenders are willing to finance higher-risk projects because the risk is offset by higher interest rates. Historically, many developers have veered away from private funding, viewing it – along with funding options like mezzanine financing – as being the kind of financial headache they want to avoid.
In the current climate, though, private lending can be a viable, even sensible, choice for residential projects. Fewer pre-sales, higher LVRs, and the option of interest-only repayment terms can make going private an attractive choice for SME developers who feel confident in project delivery.
Where, for example, banks are only willing to finance at a 65% or 70% LVR, non-bank lenders often go up to 80% or 90%, which can make getting capital-light projects off the ground easier. Similarly, banks may require pre-sales to cover between 80% and 100% of the loan, whereas private financers are often willing to accept no pre-sales at all.
This, in turn, has trickle-down benefits.
Fewer pre-sales mean less time is spent on marketing and sales, which cuts down holding costs. Builders are more confident in a start date for construction – rather than that date being contingent upon pre-sales – so tender prices are lower. Marketing and legal costs are also lower.
It’s a generalisation to say that private lending is ideal for smaller residential developers, but the hidden cost of bank loans, especially in the current climate, make it an option certainly worth considering.
Securing Private Funding
If you think private funding could be a viable pathway for your future projects, it’s important to approach it in the right way.
Private funding is not a lesser funding option for developers with bad records – it’s alternate financing, with the much of the same due diligence and strict regulation that characterises bank lending. The difference, of course, is that a greater tolerance for risk is offset by higher interest rates. As such, conducting proper feasibility studies, articulating key asset, financing, and exit details, and honestly providing your history is essential.
When you’re selecting a private financier, work with a broker that specialises in development funding. They may be able to facilitate more favourable loan conditions by recommending specific funding structures, or directing you towards lending partners with a demonstrated record of financing similar projects.
Finally, don’t get hung up on the interest rate. It’s one small piece of the financing puzzle, and understanding the overall impacts of a loan – versus just the interest – is what matters.