Property development finance: how it works, and how to get it right

What development finance covers

Development finance is lending to buy a site and build on it, then repay from selling or refinancing what was built. It covers small projects (a knock down and two townhouses, a duplex, a few lots of subdivision) right through to apartment buildings, industrial estates and commercial builds. The same project often needs more than one loan over its life:

• Site acquisition: buying the land, sometimes before development approval is in place. See site acquisition and land bank loans.
• Construction: the main development loan, drawn in stages as the builder completes work.
• Mezzanine or preferred equity: a second layer of funding that sits behind the main loan when the developer's own money doesn't stretch far enough. See mezzanine finance.
• Residual stock: a loan against finished units that haven't sold yet, so the construction loan is repaid on time. See residual stock loans.

How a development loan differs from a home loan

A home loan is repaid from your income. A development loan is usually repaid from the project itself. ASIC describes development lending as negative cash flow lending: there is no income to pay interest while the project is built, so interest is usually capitalised (added to the loan) or paid from the loan as it is drawn, and the loan is repaid by selling or refinancing the finished project. ASIC notes the full life of a project may take 36 to 60 months.

That is why a development lender looks hardest at the project: the site, the approvals, the builder, the costs, the end value and whether the sales will settle, as well as the developer's experience and the money they are putting in.

The numbers lenders look at

• Total development cost: everything the project costs, including the site, construction, consultants, council and authority costs, contingency, and the interest and fees on the loan itself.
• Gross realisation value: what everything built is expected to sell for, usually set by an independent valuation.
• Loan to cost: the loan as a share of total development cost. It tells the lender how much of your own money is in the project.
• Loan to gross realisation value: the loan as a share of the finished value. It tells the lender how much room there is if prices fall.
• Margin on cost: the expected profit as a share of total cost. A thin margin leaves little room for cost overruns or a softer market.
• Presales: contracts already signed for finished units, often with deposits paid. Banks have traditionally looked for presales before lending on residential projects.

How a ratio is measured matters. ASIC has pointed out that a loan quoted on a completion basis at, say, 70% of cost is likely to be closer to 80 to 90% during construction. Lenders each measure and set these ratios their own way, which is one reason two lenders could offer very different terms on the same project.

Banks, non bank lenders and private credit

Banks fund many development projects, particularly well located ones with an experienced developer and strong presales. Non bank lenders and private credit funds have become a large part of the market too. ASIC estimated Australia's private credit market at around $200 billion in 2024, with roughly half focused on real estate, including construction and development finance. The Reserve Bank notes that Australian private credit funds are more exposed to real estate, including construction and development, than funds in the United States.

ASIC notes that after the global financial crisis, bank capital rules made development lending less attractive for banks, and that private credit brings a different risk appetite with fewer terms and conditions, giving some borrowers access to funding they may not otherwise have. That flexibility generally comes at a higher price, so compare the full cost. The right lender depends on the project, the timing and the developer.

What lenders usually ask for

1. A feasibility study: costs, end values, timing and profit, ideally in a recognised format.
2. Approvals: the development approval and its conditions, or a clear path to them.
3. The build contract and builder: usually a fixed price contract with a builder the lender accepts, plus a quantity surveyor's report on costs.
4. A valuation: arranged by the lender, on an as is and an as if complete basis.
5. Presales or a sales plan: contracts, deposits and the marketing strategy.
6. The developer's track record and financial position: past projects, assets, liabilities and the equity going in.
7. The ownership structure: the company or trust that will borrow, and the guarantors.

Regulated or not: who the borrower is matters

Most development loans are made to a company or trust for business purposes, and ASIC states that loans to companies are not covered by the consumer credit legislation. But ASIC also says a loan to an individual to buy land and build homes on it will generally be regulated, even when the person borrows to develop several properties. The structure you buy in changes the rules that apply, the protections you have and sometimes which lenders will look at the deal, so get accounting and legal advice on structure before you sign for the site.

GST is part of the feasibility

Selling new residential premises usually involves GST. Since 1 July 2018, buyers of new residential premises or potential residential land generally withhold GST at settlement and pay it straight to the ATO: generally one eleventh of the price, or 7% where the margin scheme applies. That changes the cash you receive at settlement, so it belongs in the feasibility and the lender's cash flow from day one. Your accountant should advise on GST and the margin scheme for your project.

The risks lenders price in

ASIC notes construction and development finance has made up the majority of credit losses in past downturns, and is regarded as higher risk than lending on income producing property. That is why development loans cost more than home loans and why lenders look so closely at costs, builders and sales. Building in contingency, choosing a builder with a sound balance sheet and having a plan for unsold stock are what keep a project financeable when conditions change.

Where a broker helps

• Matching the project to the right lender: banks, non bank lenders and private credit funds each have different appetite for project size, location, presales and experience.
• Presenting the deal: a clear credit submission with the feasibility, approvals, costs and exit, so lenders can say yes faster.
• Structuring the whole capital stack: senior debt, mezzanine or preferred equity where it adds value, and the exit loan for unsold stock.
• Comparing the full cost: rates, establishment and line fees, and how interest is capitalised, not just the headline rate.

Joshua James works with Ace Lending Solutions and a wide range of lenders, from the major banks to specialist and private lenders, across Australia.