Introduction
Development projects are exciting opportunities to build wealth and create value, but securing the right financing is critical. In this guide, we’ll break down the key aspects of development finance, focusing on the Loan-to-Value Ratio (LVR) and how it applies to costs and the gross development value.
Understanding Development Finance
What Is Development Finance?
Development finance is specialized funding for property development projects, such as residential, commercial, or mixed-use properties. These loans are typically structured to cover land acquisition, construction costs, and associated fees.
Why Is Development Finance Different?
Unlike standard property loans, development finance is tailored to the unique cash flow needs of a project, with repayment often tied to the project’s completion or sales milestones.
Loan-to-Value Ratio (LVR): A Key Metric
What Is LVR?
The Loan-to-Value Ratio (LVR) measures the size of the loan relative to the value of the secured asset, expressed as a percentage. In development finance, LVR is a vital consideration for lenders and developers alike.
LVR and Loan-to-Value Costs
- Definition: LVR in relation to costs compares the loan amount to the total development costs, including land purchase, construction, and soft costs (e.g., planning and legal fees).
- Example: For a project with $10M in total costs and an $8M loan, the LVR to costs is 80%.
- Why It Matters:
- Helps lenders assess risk based on the project’s overall financial requirements.
- Developers can use it to determine how much equity they need to contribute upfront.
LVR and Gross Development Value (GDV)
- Definition: LVR to GDV calculates the loan amount as a percentage of the project’s estimated final value upon completion.
- Example: For a development with a projected GDV of $20M and an $8M loan, the LVR to GDV is 40%.
- Why It Matters:
- Offers insight into potential profitability and the developer’s margin.
- Lenders use it to evaluate whether the project’s end value supports the loan amount.
Balancing the Two Metrics
- Lenders’ Perspective:
- Lenders typically impose maximum thresholds for both LVR to costs (e.g., 70-80%) and LVR to GDV (e.g., 50-65%) to mitigate risk.
- Developers’ Strategy:
- Striking the right balance between these ratios is key to securing favorable loan terms while ensuring adequate project profitability.
Other Considerations in Development Finance
Staged Drawdowns
- Development loans are often released in stages, tied to project milestones.
- This minimizes interest costs and aligns funding with cash flow needs.
Pre-Sales Requirements
- Many lenders require a certain percentage of units to be pre-sold before approving or releasing funds.
- This provides added security for the lender and demonstrates market demand for the project.
Tips for Securing Development Finance
- Prepare Detailed Documentation: A comprehensive project plan, including feasibility studies and financial forecasts, is essential.
- Demonstrate Strong Experience: Lenders prefer working with developers with a proven track record. If this is your first project, then m
- Work with Experienced Mortgage Brokers: Mortgage brokers with expertise in development finance can connect you with specialist lenders who understand the complexities of development projects and offer tailored solutions beyond what traditional banks provide.
Conclusion
Understanding the essentials of development finance, particularly the role of LVR in managing costs and assessing gross development value, is crucial for any developer. With the right knowledge and preparation, you can secure funding that aligns with your project goals and sets you up for success.
If you’ve got a development project you’re considering, then we invite you to make a time to chat.