Residential v. Commercial Development Loan

Residential Development Loan

• A residential development loan is designed to finance the construction of residential properties, such as apartments, townhouses, or duplexes, on a single land title.
• These loans are typically used for smaller-scale projects, usually up to four units, and are structured to release funds in stages based on construction progress.

Commercial Development Loan

• A commercial development loan is used to fund larger-scale projects, such as office buildings, shopping centers, or large apartment complexes.
• These loans often involve more detailed paperwork and higher interest rates compared to residential loans.
• They are designed for developments with more than four units or commercial purposes, and funds are also released in stages based on construction milestones.

Residential Development Loan

LVR

• Small developments (up to 4 dwellings):
  • For 2 dwellings: Borrow up to 95% of the land and construction costs (hard costs).
  • For 4 dwellings: Borrow up to 80% of the land and construction costs (hard costs).
  • Borrow up to 100% of the market value of the property plus any costs associated with completing the purchase with the help of a guarantor.
• Medium developments (over 5 dwellings):
  • Borrow up to 70% of the land and construction costs (hard costs).
  • Borrowing more than 70% is possible with a private lender but they will charge a higher interest rate than the commercial rates we can negotiate.
  • You need to meet 70% of the GRV (gross realisation or on completion valuation).
  • A profit margin of at least 20% of costs is the minimum bank feasibility requirement.
  • Loan term: Up to 3 years.
  • Minimum loan size: $1,000,000.
  • Maximum loan size: Anything over $20 million considered on a case by case basis.
  • Borrowing at higher LVRs means you’ll pay a higher interest rate with a private lender.
  • Residual stock loans are available to help maximise your return on investment.

Contingency Funds

• Some banks require you to have contingency funds but some don’t! We can help you find a more flexible lender and negotiate higher Loan to Value Ratios (LVRs) and lower interest rates than you would normally be able to qualify for if you were to go to your own bank. We have a range of major banks and non-banks to choose from and understand how to build a strong residential development loan application.

Guarantor

• If you wanted to purchase and develop land in a joint venture structure, typically the project manager and the service partner would be appointed as directors (and guarantors). The money partners in the trust structure would be appointed as shareholders/unit holders. Generally speaking, all shareholders are required to provide a guarantee by default but this is negotiable depending on the strength of your case. In particular, if your Loan to Value (LVR) is low, we can negotiate to just have directors and shareholders of significance to provide guarantees.

Trust Structure

• Some banks require you to set up your loan in the name of a company or trust because the residential development loans are unregulated. For most lenders, this isn’t a requirement of approval.

Progress Payments

• The lender will release funds at the end of each stage of development:
  • The deposit.
  • Base stage.
  • Frame stage.
  • Lock-up stage.
  • Fixing stage.
• To receive each progress payment, it’s simply a matter of signing a progress payment request and sending it off to the bank along with an invoice from the builder. For the first progress payment, you’ll have to provide a copy of the receipt from the builder showing that you’ve sent them the funds you’re required to contribute. Getting progress payments can be delayed due to bank mistakes like losing your files but it helps if you have a specialist mortgage broker on your side who can manage all of this for you. In this way, the progress payments can be smooth and you won’t be left in cashflow limbo with builders and tradesmen down your throat asking for payment.

Development Plans

• Along with your personal financials, most lenders will also want to see a property development business plan or a feasibility plan showing the costs of construction versus potential profit; showcasing that you’ve done your due diligence on the project:
  • What funds you have to put towards completion (not including your security for finance).
  • Contingency funds in case things go wrong (some lenders like to see 10-20% in contingency funds if you’re an owner builder).
  • Your experience as a developer in the construction of similar-sized projects.
  • The experience of the building team (including their certifications).
  • A description of the site, its location and zoning.
  • A design concept.
  • The costs including landing, construction and soft costs.
  • Construction timeline.
  • How you plan to sell the properties or whether you have tenants lined up.
• There are firms and companies that can help you draft a professional property development plan. By doing so, you have a much stronger chance of getting approved.

First Time Residential Developer

• Although you’ll generally need previous development experience in either a developer, builder or project manager capacity, one of our lenders may be able to help you if this is your first time.
  • You can borrow up to 70% of the Gross Realisation Value (GRV) or 80% of the hard costs.
  • Available for up to four dwellings up to $1,500,000.
  • Some lenders don’t need proof of income if you plan to sell the properties on completion.
  • No presales are required for small duplex, townhouse and unit developments.

Feasibility Study

• The bank wants to know that you’ve accurately calculated the costs of construction versus your return on investment or profitability margin at the end of the project.
  • Development Application (DA): These costs can vary from council to council.
  • Construction costs: This includes hard costs for material, paying builders and contractors, overruns such as where excavation machines are needed to cut into rock or when you’ve already presold a unit but the customer wants to upgrade building materials or finishes.
  • Selling the property: There’s stamp duty and professional fees for real estate agents and solicitors that can amount to roughly 6.5% of construction costs.
  • Unpredictable overruns: Costs can quickly blowout as projects get delayed – you can’t control this but you need to factor a certain buffer based on your own feasibility study and market research.
• This is not an exhaustive list of costs but it gives you some idea of what you’re up against. In the end, you need to work out that at the end of the project and presales, you’re 20-30% ahead in profit. If so, you’ll have a good chance of getting approved.

My Financial Position

• The lender will either ask for a letter from the real estate agent to confirm the market rent income or they’ll use the rental figure estimated by the bank valuer. They can accept up to 80% of this projected rental income which can seriously increase your borrowing power. Note: Rental income on vacant land will not be accepted but it may be accepted if there is a construction contract in place.
• Like other types of residential loans, you’ll generally need to provide your last two payslips, your last three months bank statements and your last 2 years group certificates. This is to verify your income to work out your means of making residential development loan repayments. As evidence of good character, you’ll need to have a clear credit file with major banks but one of our lenders may accept your application even if you have a bad credit history as long as you’re in an otherwise strong financial position. Your security for the loan can either be cash or equity in an existing residential property. If you need to refinance your current mortgage to access equity in your property, complete our free assessment form and let us know your plans.
• Unlike a commercial development loan, you don’t need to pre-sell any of the properties or units in the development in order to get approved for a loan. There may be exceptions to this rule if you’re planning to build in an area outside of a metro or inner city or particularly in a rural location, which is seen as a higher risk. In any case, having some presales does add a lot of strength to your application! Many lenders require presales to equal the amount of debt but some can take less. For example, with a 4 townhouse development in a high demand area, the bank will still consider your application if you have anywhere between 0-4 presales.

Soft Costs

• Depending on your investment strategy, you may actually need two to three loans throughout the entire development process, specifically:
  • A “land loan” to cover the cost of buying the block of land.
  • The construction loan, to cover the building costs.
  • An investment loan if you’re planning to hold on to one of the properties.
• Soft costs are generally considered as costs that aren’t labor and materials:
  • DA approval from the local council.
  • Clearing the block of land.
  • Driveway and landscaping.
  • Architects.
  • Engineers.
  • Legal fees.
• Many first-time residential property developers are often surprised that the development loan only covers the land and construction costs. Make sure you take into account these extra costs when calculating the total cost of development. The way around it is if you bought the block of land a few years ago and have paid off a good part of the land loan. If you have the equity, you can cash out and use these funds to cover some of the extra costs.
• We can help you refinance your existing mortgage to fund a residential development loan!
• Alternatively, if you can provide formal written quotes for these soft costs we can often get the bank to extend the loan for these costs. It really depends on the nature of the work and the lender that we’re working with as to whether this will be possible or not.

Switching to Residential Loan

• When the project is complete and you have been given an Occupation Certificate, you can potentially refinance to a residential home loan and save thousands by paying home loan interest rates. You need to have been paying the development loan for at least 12 months before you can refinance so as to avoid break costs.
• This option is typically only available to developers that have sold one or two units to meet the standard 100% debt cover requirement. In this way, you can save thousands in mortgage repayments and potentially sell at a higher price in the future. This is for sophisticated investors only so we recommend that you seek proper financial advice before considering this investment strategy.

Tax

• Once the development is complete, you may decide that you want to hold on to one of the premises as an investment property. If there is enough profit from selling the other one or two properties, you may be able to buy the property without the need for a home loan. If there aren’t enough funds, your mortgage broker can help you refinance the property to an investment loan so you can pay out the development loan.
• Check out the ‘Building and Construction – residential premises’ page on the Australian Taxation Office (ATO) website for information regarding tax implications when selling a property in a multi-dwelling development. For example, you’re liable for the Goods and Services Tax (GST) when selling one of your units and dwelling but you calculate the GST owed using the margin scheme and save on this tax cost. You should always seek tax advice from your accountant and financial advice from a financial professional to ensure you’re making an investment decision that works best for your financial situation.

Commercial Development Loan

LVR

• Standard commercial property: Borrow up to 75% of the land and construction costs or Land to Development Cost Ratio (LDCR) or 65% of the on completion value. With a guarantor, you can borrow up to 100%!
• Specialised commercial property: 50-60% LDCR for specialised commercial properties including landfill or waste management facilities.
• Max loan amount: Anything over $20 million on a case by case basis.
• Max loan term: Up to 3 years.
• Interest only period: For the duration of construction up to 3 years.
• Line of credit: Available. However, line fees can be expensive.
• Low doc, no doc and lease doc loans: Not available.
• Bad credit loans: Not available.
• Residual stock loans: Available to help maximise your return on investment.

Security

• Registered mortgage over the property being developed.
• General Security Agreement (GSA) over all of your rights and undertaking in relation to all security property, including pre-sale deposits.
• Directors’/shareholders’ guarantee.
• Rights to designs and intellectual property (an architect can help with this).

Property Valuation

• There is typically two valuations that take place. One is for the construction cost plus the land value (75% LDCR) and the other is for the on completion value, which is usually higher. This is the reason why the LVR is generally lower (65%) for this component why the bank bases the final loan amount on the lower of the two.
• For example, if the land costs $2 million and the cost to build the development is $6 million, the total cost will be $8 million and you can borrow up to $6 million (based on the initial valuation and not including the soft costs of construction). However, if at the end of construction of a 30 unit block, selling at $500,000 per apartment, the final value might be $15 million instead. So at an LVR of 65%, you can borrow up to $9.75 million. Note: banks will usually take the lower of the LDCR or LVR, so you might only be able to borrow up to $6 million for entire development.
• The bank will organise for a valuer that specialises in the type of commercial property that you want to buy. They will base the valuation off the development plans you have in place: it’s quite a thorough process. You can organise the valuer yourself but they have to be certified, usually with the Australian Property Institute. Bear in mind that you’ll have to foot the bill for this (anywhere between $5,000-$10,000).
• The valuer will want to know:
  • How many units are being built.
  • Where the property is being built.
  • The size of each unit (units less than 50sqm2 are known as studio apartments and lenders are conservative on approvals and LVR).
  • Comparable sales in the area for the type of property you want to buy i.e. industrial, commercial, retail or residential.
  • The cost of construction (hard costs not soft costs).
  • How much you’re contributing to the purchase and contingency funds you have in place.
  • Construction schedule and date of completion.
• For a unit or apartment block development, you generally need at least 70-90% pre sold.
• You need experience in building commercial properties either in a development capacity (small development) or as a project manager, head engineer or an on-site manager for a commercial construction company.

Property Revaluation

• There’s usually an annual review requirement for commercial developments and the property will get revalued every 3 years, or 5 years for commercial development loans at a lower LVR. Basically, banks are concerned with fluctuating prices, particularly in locations in economic turmoil.
• The valuer will need to ensure that the commercial property has financially strong tenants or that the business tenants will remain in the property for the long term. If tenancy rates drop and there are signs that there is a loss of appetite for the type of property you own, the bank may call in the loan and move to lower the LVR in line with how many leases or tenants there are in the property. The bank will usually run a weighted average lease expiry (WALE) to work out when properties are likely to become vacant. This happens a lot with pub owners who decide to sell up when the state or federal government introduces laws related to smoking or drinking. Trade can quickly drop as patrons depart so pub valuations soon follow. In the past, it was found that the remaining commercial loan was at 110% LVR!

No matter whether you’re looking to build a block of residential units, a warehouse, a pub or a hotel, a specialist valuer is needed to look over your plans. You’ll need to have DA approvals so the bank isn’t approving a commercial development loan for a child care centre in a location zoned industrial, for instance. In most cases, you’ll be able to borrow up to 50-60% of the property value but it really depends on whether the property is considered a standard property or specialist property. The development of specialised properties like service stations and pubs may be considered more favourably if there’s a genuine need for the service such as in a new suburb. The location and its population may support the property that you want to develop and this will help attract business tenants who want to lease the premises for their business.

Oversupply

• Choosing the right location is really important when it comes to commercial development. Because it can take anywhere from 2 to 3 years to complete a site, you have to be quite forward thinking and consider changes in the market.
• From a residential point of view, consider whether your proposed block of units will exacerbate a growing overdevelopment problem. Sometimes there might be plans in the works to build large apartment buildings in the location you want to develop.
• Check with local council about approval plans for the suburb. Cities with steadily growing populations including strong migration numbers are always a plus when it comes to developing residential units but you have to consider the appetite for the particular type of commercial real estate you’re planning to construct.

Studio Apartments

• Units under 40sqm2 are difficult to get approved. Even if you have plenty of experience in developing commercial properties, banks often place a big question mark over apartment developments where the units are less than 40sqm2.
• Commercial developers often try to limit the size of each unit to maximise the amount of tenants they can sign up to the property. The problem is the market for these types of units is limited to students, young singles or couples, or people after cheap rent. Banks are wary about commercial property with limited market appeal so you may be declined for a loan and have to increase the size of each unit just to get approved.

Due Diligence

Although developments can be a long process and involve a lot of hard work and planning, there are a few things you can do to ensure a smoother ride:

• Ensure you’re developing in the right zone by checking with the local council before applying for a commercial development loan.
• Be aware of other council plans; infrastructure changes can affect your property and the type of tenants you’ll attract.
• Research the location on commercialrealestate.com.au or realcommercial.com.au to see if the market suits your development.
• Assemble a strong team with a licensed builder, experienced tradesmen, an architect, and possibly a town planner for a smooth DA process.

Commercial Property Loan (to purchase or invest, not for development projects)

What are commercial property loans for?

• Financial solutions for acquiring, refinancing, or developing commercial real estate.
• Ideal for investors and business owners seeking to grow, invest, or establish a dedicated business space.
• Flexible terms compared to traditional home loans.

Who are commercial property loans for?

• Investors: For generating rental income and long-term capital growth.
• Business Owners: For securing premises for their own business operations.

What do lenders consider?

• Credit Score: Crucial for approval and favorable terms.
• Financial History: Stability shown through financial records.
• Business Revenue: Ensures sufficient income to cover repayments.
• Loan Amount: Aligns with financial capacity.
• Collateral: Usually required; standard properties preferred.

What types of properties affect eligibility?

• Standard Properties: Easier to finance (e.g., offices, retail spaces).
• Specialised Properties: Harder to finance (e.g., hotels, aged-care facilities).

How does the purpose affect terms?

• Investment (Low Risk): For leasing out commercial property.
• Owner-Occupied (Medium Risk): For the business’s own use.
• Working Capital (High Risk): For financing daily operations.

What about income verification?

• Full Doc: Complete financial statements required.
• Lease Doc: Proof lease income covers repayments.
• Low Doc: Partial income evidence, such as bank statements.
• No Doc: No income evidence, usually with higher interest rates.

How to select the right lender?

• Match with a lender fitting your specific needs through an experienced commercial mortgage broker.

How to apply for a commercial property loan?

1. Initial Consultation: Understand business goals and needs.
2. Document Submission and Review: Provide necessary documents.
3. Lender Negotiation: Negotiate the best terms.
4. Indicative Funding Proposal (IFP): Outline likely loan terms.
5. Application Submission: Arrange valuation and submit the application.
6. Co-ordination with Your Team: Involve solicitor and accountant.
7. Finalisation: Address any concerns and ensure conditions are met.
8. Adding Extra Value: Offer advice to increase property value.

What documents are needed?

• Financial Statements: Including profit-and-loss statements and tax returns.
• Lease Agreements: If applicable.
• Property Details: Valuation reports.
• Business Plan: For new businesses or property development.
• Income Verification: Depending on the loan type.

Residual Stock Development Loan

• Term: 2-3 years, but you may hold units longer to sell at a better time.
• Market Downturn: Selling residual stock can be challenging, especially in CBD Brisbane and Melbourne.
• Refinancing: Possible with specialist lenders, including some non-bank lenders.
• LVR: Lower LVR for more units financed due to higher risk.
• Borrowing Options:
  • Up to 80% of each unit’s value.
  • Up to 100% with a guarantor.
• Loan Amount: Over $5 million considered case by case.
• Loan Term: 1-2 years, interest-only.
• Options: Low doc available, bad credit loans not available.
• Preference: Lenders prefer metro locations.
• Interest Rates: Slightly higher with specialist non-banks, but negotiable.

Who should I have on my team?

• Builder
• Solicitor
• Accountant
• Architect
• Surveyor
• Town planner
• Engineer
• Real estate agent

Property selling costs

• Agent Fees
• Marketing Costs
• Conveyancing Fees
• Capital Gains Tax (CGT)
• Presale Repairs and Renovations
• Styling/ Home Staging
• Auctioneer’s Fees
• Lender Fees
• Moving Costs

Property purchasing costs

• Minimum of 5% deposit
• Stamp duty
• Property title transfer fee
• Registration fees
• Conveyancing fees
• Inspections including building/strata and pest
• Home loan set up fees
• Lenders Mortgage Insurance (LMI)