Most property developer's quit when they simply do not have enough cash to get into developing.
Here's why they must not quit...
Most wannabe developers automatically assume that the vast sums of money involved in starting, building and completing a project immediately excludes them from playing the property development 'big money' game.
How wrong they are. Using an actual LIVE development project, you will discover how a 'one- man' developer put very little money down for a profit potential in the tens of millions.
Sure, a newbie developer with very little personal wealth may struggle to float a $200m project, however, you might be surprised just how easy it can be to fund a project that would typically be far above your personal borrowing capacity.
In my previous article, The 7 critical factors to obtaining successful development funding that will have banks, joint venture partners and gap funders kicking down your door, the main focus was on understanding the key factors to consider when applying for development debt funding.
In this article, I will show you 5 funding strategies that will help you move from doing small 'splitters' developments or little townhouse projects and, instead, jump into the big league.
Five funding sources to make you more money doing bigger property development projects
Let me ask you this: if you could make a $30m profit or a $300k profit for the same investment in your time and money; which would prefer?
The answer seems obvious but many less experienced developer's I speak with think the amount of money they need is proportionate to the size or profitability of the project. Likewise, many assume the larger projects require proportionately more time and, therefore, some constraints on their personal cash flow.
The reality, in my experience, is quite different. I've worked with a number of developer's over the last 10 years and the size of the project has little correlation with how much money and time they have invested.
So let's look at some alternative funding sources beyond your personal capital and the traditional commercial bank loan....
1. Manufactured Equity to create your own equity
The term 'manufactured' equity is quite commonplace nowadays and refers to the process of adding value to a development site by either rezoning the site or by obtaining a development approvals for a different use, for example, a single detached house to high-density units.
REAL LIFE EXAMPLE
My development partner recently amalgamated 6 detached home lots into one larger site on the Sunshine Coast by way of obtaining a development approval. The planning code allowed for 73 units to be built across these 6 home sites. Together the individual land lots are worth about $8,000,000 but as a newly approved amalgamated development site combined they are valued at $18,000,000. The developer anticipated this and offered the vendors a premium for each property totalling $13,000,000 (against an initial value of $8m).
With a new DA, his manufactured equity is $5,000,000 based on the difference between what he owes the vendors and the valuation ($18,000,000 - $13,000,000).
This manufactured equity of $5,000,000 became his equity contribution for bank funding purpose. It cost him about $500,000 to obtain the approvals which is a 1000% return on his costs.
....and that's assuming it cost him $500,000 to get the approvals.
Imagine applying for a $70m facility with only $500,000 in cash/equity?
Not gonna happen. But with $5m? It gets easier...but not quite there yet.
Warning - some lenders want what they call 'hurt' money in the deal. This is money the developer has in cash (eg $500,000) and supposedly acts as an incentive to keep the developer engaged if things go wrong. I don't know any developer that would walk away from $5,000,000 in equity nor $500,000 in cash. Choose your lender wisely.
2. Vendor Finance where the seller leaves some of the purchase price for later
Also know as 'Seller finance', vendor finance is where the vendor agrees to leave some or all of the purchase price in the deal. The benefit of this is the developer then only needs to seek funding for the difference and usually on better terms.
The reason the vendor may agree to this is they may be offered a price above the undeveloped valuation of their property. Perhaps they don't need to settle right away and preferred to receive some interest along the way.
The key is to understand the vendors motivation for selling and their financial needs.
3. Joint Ventures where you provide the expertise and others put in the cash
A joint venture is a form of short term partnership and is usually governed by a joint venture agreement which stipulates the terms and conditions (and obligations) of each joint venture partner.
The idea is each JV partner brings something unique to the partnership. For example, a developer may provide the necessary time and expertise to undertake the project successfully. The developer may agree to use the owners land as security against a loan facility for construction and indemnify the owner from any liability with the lender. The developer may also guarantee the loan. So the risk to the landowner is quite low and the profit share above the land value can be quite significant.
There are many different scenarios and formula's for structuring a JV agreement where ultimately everyone benefits.
In essence, a JV can be an excellent source of funding with the terms being much more flexible than a typical development loan.
4. Crowdfunding as a cost effective source of funding from everyone
The impressive profit potential compared against actual sales achieved already and the proven costs means the developer can utilise some of his future profit today by selling a right to some of this future profit in exchange for cash provided today by 'the crowd'. It's a big win-win for all involved.
Not only has the developer enjoy the benefit of using other people's money to fund much of the initial council approvals which cerated the huge equity uplift, but he was able to continue earning an income (project management fee).
Some developers can go without earning an income for years which doesn't help with future credit applications. So many developer's risk their own capital while struggling to keep their head above water over the lifetime of a project.
Not with crowdfunding: earn and income and have part of the development costs funded by private money.
Most investments where investors have pooled their funds are regulated by ASIC and are known as 'managed investment schemes'. Raising capital from the general public is fraught with compliance risk.
Hotspotcentral established the capital raising structure for this developer so they do not have to get involved in the detail associated with raising funds from the general public.
Locating crowdfunding investors who understand these specialised investments can take time. It is therefore a good idea to establish the crowdfunding vehicle and raise enough interest prior to finding a site. Some vendors may want the site settled quite quickly so finding a site and then trying to raise capital can prove challenging.
5. Gap Funding provides the last little bit of money that could otherwise kill a project
Not all developers have the capacity to raise capital from traditional public sources like the 'big end of town': those large institutions who pay single digit returns to their investors and use their funds to generate huge profits.
What if the developer has a foot on a few profitable sites but is limited by their own personal financial circumstances? Do they let these projects go?
Raising more capital to fund the gap in their own personal equity can lead to larger projects or the ability to take on more projects.
In Australia, as is the case with forming syndicates, there are legislative requirements relating to the raising of capital so make sure you speak with an appropriately qualified and experienced solicitor beforehand.
For investors, gap funding can be very lucrative as it is usually the last source of capital when all other options have been exhausted.
Become a CrowdFunder or Developer?
This is a question I'm often asked. Why didn't I become a developer instead of building a business around research and raising capital for other developers?
Frankly, I stumbled upon the idea of 'gap funding' capital raising.
When I launched the first version of our property market research platform Boomtown, it became very popular in the various property magazines and gained thousands of users who then started to ask me where I would invest my own money.
I then created one of the first development crowdfunding models known as 'armchair development' based on the idea of investors partnering with me to capture both the development profit and the capital gains associated with retaining a property on completion of a project.
These investor would suggest it works...
Anyway, what I learned by partnering with various developers over the years are the kinds of personal characteristics needed to be a successful developer. Some of the characteristics can be learnt through experience but others have to be innate i.e. they are born with them. Development is not easy and I've seen people fail...badly.
So the idea of bringing some much needed capital to a project in return for an outsized share of the profits, delivered by someone with a solid track record and the right character traits, makes more sense to me.
Michael is the founder of Australia's only data-driven property development and location research tech-business that educates and connects investors with highly profitable, risk mitigated property development investments.
Michael FULLER, FOUNDER - HOTSPOTCENTRAL