How Does Property Development Finance Work?
Property finance is a crucial aspect of real estate development, offering funding solutions for both small-scale residential projects and large commercial developments. Whether you’re planning to build a new home, develop multiple residential units, or undertake a commercial property project, securing the right finance is essential for the success of your venture.
This blog will explain how property development finance works and what you need to know as a property developer before applying for one.
What Is It?
This type of finance refers to the loans available to property developers to fund the purchase of land, construction, and other associated costs of a development project. This type of loan is short-term and designed specifically for development projects. It is usually structured as a loan with staged payments, also known as “drawdowns”.
These payments are made in phases, aligned with key milestones in the development, such as land purchase, construction stages, and project completion. The staged nature of the finance helps to manage cash flow and ensures that developers have access to the funds when they are needed.
Types of Property Development Loans
There are several types of property development finance available, and choosing the right one will depend on the scale and nature of the project. These include:
- Senior Debt: This is the primary loan used to fund a large portion of the development project. It covers up to 70% of the project costs and is secured against the property being developed. The lender takes priority over other creditors, meaning they will be repaid first if the project fails.
- Mezzanine Finance: This is a secondary loan that bridges the gap between the amount the developer can raise through senior debt and the total project cost. It’s a higher-risk loan for the lender, as it ranks below senior debt in repayment priority. Due to its risk, interest rates for mezzanine finance are considerably higher.
- Bridging Loans: These are short-term loans used to cover temporary funding gaps, such as the purchase of land, before securing long-term finance. Bridging loans are usually more expensive but provide quick access to funds.
- Development Exit Loans: Once a project is nearing completion, developers can seek this loan to repay their original loan amount and provide breathing space while they sell or lease the developed properties.
How Are These Loans Structured?
Property development loans are typically structured around the following key components:
- Loan-to-Cost Ratio (LTC): This is the percentage of the total development cost that the lender is willing to finance.
- Loan-to-Value Ratio (LTV): This ratio compares the loan amount to the projected value of the completed development. Lenders will cap this at 60-70% of the end value.
- Interest Rates: They usually come with higher interest rates than standard mortgages due to the increased risk associated with development projects. Rates vary depending on the type of loan, the project’s risk profile, etc.
- Repayment Terms:They are usually short-term, with repayment terms ranging from 6 months to 3 years.
Looking For a Property Finance Specialist? You’ve Got Us!
Zen Finance Pty Ltd is a trusted property finance expert helping property developers like you thrive in the real estate market. We can help you find the optimum finance for your development project. Call 61 4 38811883 to get started.
