I need Residual Stock or Take Out Finance (left over units or townhouses from developments)!
In what seems to have been a matter of weeks, but in reality has been a progression over the past 12 months, the major banks’ credit appetite for development (or construction) finance has reduced due a number of factors including tightening in land values, increased development costs, quality and criteria of pre-sales and on completion values. The combination of these factors has resulted in the banks requiring larger amounts of equity, in some cases 25-30% more, and a higher number of pre-sales to commence projects, compared to the banks’ criteria this time last year.
However, since last year there have been a number of new lending structures and alternate funding lines Red & Co have been taking advantage of for our developer clients in order to offset the banks subdued appetites. These include obtaining funding from non-bank and specialised lenders who have increased appetite for what would have previously been considered a safe ‘bank deal’. Private Mortgage Trusts also fit into this category. These trusts have appetite for no pre-sales financing, land banks, mezzanine and first mortgage construction finance, which allows developers more options when it comes to where the pre-sales come from, and also greatly reduces the commissions payable from a sales agent, who typically charge 7-8% commission per sale, to enable developers to use a local agent who charges 2-3% per sale.
In the larger projects, we are still finding local first and second tier banks have an appetite for conservatively geared development finance, with mezzanine funding sitting behind them as a second mortgage facility, provided there are strong quality local pre-sales provided where the finance on exit is strongly mitigated. In this theme, we thought this month would be a good opportunity to talk about Residual Stock Finance, or Take Out Finance, where the developer can borrow against unsold stock in a property development.
What is Residual Stock Finance and the Obstacles that Property Developers are facing?
Since APRA told the banks to put a 10% handbrake on investment lending last year, banks have been reluctant to hold concentrated parcels of units (e.g. more than 3 units) in the one development. As such, they have applied harsher credit criteria to developers looking to retain stock in completed developments and have been more critical on income. In some cases, banks are not relying on rental from the units proposed as security and are only utilising income from outside of security properties which can reduce borrowing capacity by 40-50%.
What Funding Structures and Take out Finance options are available to Property Developers?
There is no doubt that the banks and building societies are feeling the pinch of APRA’s intervention, but as one of Australia’s Top Commercial Finance Brokerages Red & Co has been able to successfully arrange funding for our clients by taking advantage of several new funding structures:
- Some banks are still providing commercial facilities for unsold units and townhouses; however, these are valued on an in-one-line basis (assuming all properties were held on one title, instead of being on individual titles). This generally causes a 15-20% reduction in the property’s value and is not always viable for developers.
- There are non-banks that allow take out and recapitalisation finance which is secured against the residual development units. This is valued on the gross realised values of the units that are left over and can also be utilised to provide an extended sell out period; for example, the facility might only have a 2- or 3-year term.
- Specialised lenders are actively seeking residual stock finance, and providing facilities of between 1-5 years with a variety of structures available including the possibility to capitalise interest to the facility and take other commercial property as security.
- Alternatively, retail banks will provide standard residential finance on up to 3 units per development on their standard residential products up to 80% LVR. This funding generally has the lowest cost of these structures, but is dependent on an ability to provide tax returns and substantiate borrowing capacity outside of the development.
What Advice do you have for Property Developers & Investors?
- Work with highly experienced and solution focused advisers who have a track record of success and deep wealth of knowledge in their field, including reviewing their recent case studies.
- Don’t assume that because your banker settled a deal for you in the past they will do it again. Countless developers and investors have recently been caught out by overnight changes in bank policies. Protect yourself and your assets by working with an experienced brokerage like Red & Co that has multiple banking relationships across Australia.
- Sales and Marketing are even more critical than they have ever been at this point in the cycle. Increase your investment and contacts in this area with increased focus on the local market.
- With your finance, begin with the end in mind and arrange your finance in a way that doesn’t compromise your existing portfolio and support your pipeline of projects moving forward.
- Hedge your banking relationship by utilising multiple lenders as well as banks that understand development finance and where you are going.
Jayden Vecchio is the Director of Red & Co Finance, awarded Vow National Broker of the Year in 2015, and 2016. Red & Co Finance is a Finance Brokerage that begins with the end in mind specialising in Development Finance. They have settled over $380M in lending over the past 3 years alone helping property developers in Brisbane, Gold Coast and Sunshine Coast with getting developments completed quickly, reducing the risk and increasing profitability.