Construction and Development Finance

Key takeaways

• Sized against both loan-to-value AND loan-to-cost - whichever binds first.
• Presale requirements are common on multi-unit projects.
• A quantity surveyor certifies each progress claim before funds release.
• Cost overruns are the developer's problem, not the lender's.

How is a development loan sized?

Two constraints apply simultaneously and the tighter one wins.

Loan to value is measured against gross realisation value - what the completed project is expected to sell for, net of selling costs and GST. Loan to cost is measured against total development cost including land, construction, professional fees, council contributions, interest and contingency.

A project with a strong margin may hit its LVR limit first; a tight project usually hits the cost limit first. Either way, the developer contributes the balance, typically through land equity already held or cash.

The valuation itself is specialised. A development valuation includes an "as is" land value, an "on completion" value and often a "gross realisation" figure, and lenders lend against different bases depending on the stage.

What does the lender require before the first draw?

Presale requirements are the constraint that most often stops a project. Requirements vary by lender and market conditions, and qualifying presales generally have to be to unrelated parties with genuine deposits.

How do progress draws work?

Funds are released in stages against work actually completed, never in advance. The typical cycle: the builder submits a progress claim, the quantity surveyor inspects and certifies the work as complete and consistent with the program and budget, the lender releases that stage.

Two things follow from this that catch inexperienced developers.

First, you fund the gap. The builder generally needs to complete a stage before being paid for it, which means working capital sits between the work and the draw. That gap is a real funding requirement and it is not covered by the development loan.

Second, overruns are yours. If the quantity surveyor determines the cost to complete exceeds the remaining facility, the lender will generally require the developer to inject the difference before releasing further funds. A project that runs over budget stops until equity arrives, and interest keeps accruing while it is stopped.

Plan the exit from the start. A development loan is short-term and expects to be repaid from sales or from a refinance into a term facility. Lenders will want to see which, and evidence it is achievable.

Frequently asked questions

How much deposit do I need for a development loan?

Enough to satisfy both the loan-to-value and loan-to-cost limits, whichever binds first. Land equity already held commonly forms part or all of the contribution, and the developer's funds generally go in before the lender's.

What are presales and why do lenders want them?

Contracts to sell units before or during construction, generally to unrelated parties with genuine deposits. They evidence demand and provide the repayment source, which is why they are commonly required on multi-unit projects.

What does a quantity surveyor do?

Independently reviews the construction budget and program before funding, then inspects and certifies each progress claim before the lender releases funds. They are the lender's check that the money matches the work.

What happens if the project goes over budget?

The developer generally has to fund the overrun. Lenders require a cost-to-complete assessment and will usually pause further drawdowns until the additional equity is injected, while interest continues to accrue.

Related reading

• Construction Loans: How Progress Payments Work
• Commercial Property Loans: LVR and Lease Doc
• Exit Strategies: How Short-Term Loans Get Repaid

Sources

• Financial Stability Review - commercial property and development — Reserve Bank of Australia
• Building and construction guidance — business.gov.au