7 Critical Factors to Successful Property Development Funding

What do you think is the number one factor that can kill even the most profitable property development project?

A: Lack of appropriate funding.

Yes, that's correct. Getting the all important development funding that is appropriate for the project. It's make or break. If you are considering investing in a property development project then you need to know...

The 7 critical factors to obtaining successful development funding that will have banks, joint venture partners and gap funders kicking down your door.

Without adequate funding on appropriate terms, even the best property development projects are doomed from the outset. With the tightening of lending criteria over recent years, understanding exactly what lenders are looking for is crucial before taking on a development (or investing your hard earned cash with a developer - an alternative investment path that is becoming increasingly common today).

Most developers cannot fund their projects purely out of their own capital and the more prudent would not do so anyway. As you become more experienced and take on more projects, you will quickly realise why it’s important to spread your financial risk across numerous projects ... even if it means sharing some of the development profits.

Let’s assume you have found a site that is economically viable, and your due diligence analysis is favourable. Perhaps you control the site by way of a contract or an option agreement.

The next step is to raise capital to get the project going.

When I cast my mind over the many developments I've backed over the years, I would say development funding and valuations are the two areas that can affect (and sometimes derail) even the best projects if not adequately understood and addressed.

It's important to step in the shoes of your funding partners and understand how they make a decision to lend (or not).

Let's first unpack some of the terminology you need to know.

Soft costs versus hard costs

Generally, development finance is lent as a percentage of the overall costs of a project. These costs are split into hard costs and soft costs.

Hard costs often refers to the costs of actual physical construction of a real estate development project but can include the land and acquisition costs, local council approval costs and professional fees.

Softs costs are less obvious than hard costs as they encompass anything and everything which is not directly related to the physical development of a building, e.g. loan establishment fees, interest, mortgage duty, valuation fees, legal and accounting costs, and marketing costs.

Although some lenders will provide for some of the marketing costs, in most cases the developer has to fund this cost by obtaining sufficient pre-sales to support their application.

Debt versus Equity 

Funding packages generally comprise of debt funding and equity funding. Both are key to getting sufficient development funding ... but come with very different terms and levels of risk to the lender.

Debt funding requires the developer to pay interest and certain fees, but the Developer keeps all the profit after all costs are paid.

Sources of debt funding are banks and non-banks and comprise of senior debt (where the Developer offer the lenders a 1^st mortgage) and mezzanine debt which sits behind the senior lender (2^nd Mortgage) in order of payout.

Equity funding is where the lender elects to take on some of the risk by sharing in the profit. Usually this form of funding is more expensive as it reflects the higher risk including lack of mortgage security.

Equity financing is only offered by a small number of banks and non-bank lenders and, more recently, from crowdfunding providers like us at Hotspotcentral, where everyday investors provide the funds from their SMSF or other savings vehicles.

The biggest challenge for the Developer is to get as much money together to cover most of the total development costs. Unfortunately, the difference between the hard costs and soft costs available and the total costs can result in a funding 'gap' or the shortfall after all funding sources have been exhausted.

Plugging this funding gap with private money has become a lucrative opportunity for investors in recent times, particularly when the project is already quite advanced at the time of making the investment, i.e. post DA approved, with significant pre-sales and strong valuations, and when the debt funding is already approved.

7 key development funding lending criteria

Lenders ultimately ‘sell’ money to developers and compete with other lenders depending on their unique lending criteria. As a developer, it’s your job to understand these criteria and how to adequately mitigate the lenders' risk. The financiers will assess both the project fundamentals and analyse the borrower's credentials in line with their specific lending criteria.

Over the years, my Development Managers have had to kiss a few frogs before securing quality funding packages. And keeping in mind lenders are often found via brokers, who want an upfront fee just to introduce you, it can get very expensive if the application is not successful or the parameters are simply out of alignment with your funding requirements. I’ve seen fees of $20,000 and more paid to brokers only for the funding offers to be completely unacceptable or have conditions that are impossible to meet.

At the heart of raising equity and debt funding is your ability to articulate your overall vision for your project to the various stakeholders who you want to back you and part of this includes the following: