This article outlines three fundamental stages of property development and three important considerations for property development finance. Using examples, it explains the journey from approvals and feasibility through to funding and completion, including common risks that should be tested before proceeding.
Step 1: Development Approval (DA)
Before starting any property development project, the first thing you need to secure is the Development Approval (DA). This is essentially a permit to build, and it’s crucial to know exactly what can be developed on your chosen site.
There are three key investigations to be conducted in the early stages:
• City Planning (Zoning): What type of properties can be built in this location?
• Project Design: How many units or parking spaces can be constructed?
• Civil Engineering: What are the requirements for soil environment, water, electricity, and other basic infrastructure?
Step 2: Feasibility Analysis
Now that you’ve received your DA, the next step is to conduct a feasibility analysis to ensure that the project will be financially viable. This step involves assessing both income and expenditure.
For example, let’s say a client buys land for $1.8 million. After including stamp duty, purchasing costs, and DA fees, the total investment comes to $1.94 million. The DA allows for the construction of 9 townhouse units. After market research, it’s found that each unit can be sold for approximately $750,000, bringing in total revenue of $6.75 million.
The client plans to pre-sell 4-5 units.
Here are the six main costs involved in this project:
1. Land Purchase Costs
2. Construction Costs
3. Municipal Costs
4. Loan Costs
5. Other Miscellaneous Costs
6. Sales Costs
Total costs come to $3.38 million, all of which will be financed via a loan. The project is expected to generate a profit of almost $1 million in one year, offering a 50% return on investment (ROI). The bank typically expects a minimum ROI of 15%, but this example offers an impressive 18%.
Key Considerations in Feasibility
There are two critical factors that will affect the profitability of your project:
• Construction Costs: Aside from the land, construction costs are the largest expenditure. The cost of building contracts and selecting the right builder directly influences the project’s profitability. For instance, the ratio of building contingency funds may need to be adjusted. If the contingency is too low, the bank may consider the project too risky and demand higher funds. This could reduce your project’s profitability by a significant margin.
• Loan Costs: Loan interest rates have a direct impact on project profitability, especially your funds return rate. For example, if the client were to reduce their loan by $1 million, the interest savings would result in an additional $100,000 in profit. However, this would also require the client to contribute an extra $1 million in equity, thereby increasing the funds return rate by one-third.
Cash flow is key. Many projects fail to proceed because developers run out of funds. It’s crucial to have a reliable financial partner and a solid understanding of loan options to prevent delays.
Step 3: Project Execution
Once you’ve completed your feasibility analysis and selected your builder, the project can begin to move forward. The first step is securing the loan, which requires a professional valuation and quantity surveyor’s (QS) report. This process can take between 3-8 weeks.
Next, you’ll need to meet the loan release conditions, such as hitting certain pre-sale milestones. Once the conditions are met, the bank will begin disbursing the funds.
Finally, when construction is completed, sales can begin, and the property will be handed over to buyers. Any remaining loans or associated costs will also need to be repaid at this point.
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Successful development requires careful planning, market research, realistic contingencies and a workable exit strategy. Projects that do not yet meet bank requirements may sometimes consider private lending, but the higher costs and exit risks need close review. To compare funding pathways for a specific project, contact Smart Mortgage. Returns and finance approval are not guaranteed.