How does property development finance work?
We’ll look at residential and commercial property development finance separately.
Residential property development loans
Residential property development loans are usually easier to get than commercial property loans. Lenders generally perceive them as being lower risk, and the interest rates are lower accordingly.
However, it’s important to understand that residential property development loans typically have higher interest rates than single residential property loans (such as owner-occupier or investment property mortgages, which are both perceived as lower risk).
Lenders will require you to provide the following information when applying for a residential property development loan:
- detailed development plans,
- details of your financial situation and any collateral security that you can provide to lower the lender’s risk, and
- your credit history.
The maximum loan-to-value ratio (LVR) for a property development loan varies between lenders, but it is usually a maximum of 80% for two-dwelling development projects and 70% for three-or four-dwelling projects. An LVR is the loan amount expressed as a percentage of the estimated market value of the property development project.
Once you have gained approval for a residential property development loan, the funds are released progressively as construction milestones are reached. Because you don’t borrow the entire amount upfront, your repayments start off lower.
It’s worthwhile to factor in an amount for development cost blowouts in your property development financing, otherwise you may not have enough funds to complete your project.
Commercial loans for property development
Two common commercial loan uses are:
- land banking, and
- construction loans.
Land banking involves buying a large block of undeveloped land that has been (or will be) rezoned or approved for development. Many developers divide the real estate they buy into smaller blocks to maximise their profits.
As the name suggests, a construction loan finances the building of multi-residential properties on the land.
Commercial loans for property development are harder to get than residential property development loans. They are perceived as higher risk and lenders have stricter lending criteria for commercial loans accordingly.
For example, lenders typically require a certain percentage of pre-sales. Pre-sales are sales of units/apartments or townhouses before they have been completed (including sales “off the plan”). The number of unsold residences prior to the completion of a development project is known as “residual stock”.
Higher interest rates are also usually charged on commercial loans than residential property development loans.