The FFS of Property Development… feasibility, funding & structuring

Getting the fundamentals right is critical to your success

We’re sure you’re aware that in today’s climate making money out of property development can be tough. Plus the uncertainty surrounding the banking royal commission and the looming federal election have only added to the complexities, making the property industry a nightmare if you’re not fully armed with the right information. So here’s a guide to property development, to help you choose a profitable path.

The terms in relation to property development – feasibility, structuring and funding – are all too frequently misunderstood.  And at M+H Private we’re so often reminded of the importance of meticulous planning – right from the start.

Here’s a breakdown of the three vital initial stages:

Property development feasibility

In the past it was rare for an initial detailed property feasibility study to be carried out. This is certainly not the case now. These days lenders require comprehensive analysis of your flow of funds, drawdown stages, sales timings, product type and costs.

 It’s important that you include allowances for contingencies, as well as sensitising your model to ensure worst case outcomes are identified, and an appropriate mitigation plan established. In the event of your property being unable to be sold, or worse, bankruptcy, you certainly don’t want to be left holding the baby!

The right property development structure

Your choice of entity is crucial – get it wrong and your tax payable can increase significantly. In some instances a trust may be your most appropriate structure, as it offers the most flexibility. Here’s a closer look at the options:

  • A unit trust, if the units are owned  by a discretionary trust, gives you flexibility as to where profits are distributed. A 50% capital gains tax general discount is available if the property is held for more than 12 months. (This would assume the property is no longer considered trading stock, and has therefore been converted to a long term investment.)

  • A partnership of discretionary trusts is similar to a unit trust, but the key benefit is that any taxation losses aren’t locked in as they are with a unit trust. That is, each discretionary trust could utilise its own taxation loss to offset other income.

  • A company will deliver you a 27.5% corporate tax rate, assuming it’s a base rate entity. If the property isn’t trading stock, your company isn’t entitled to the capital gains tax 50% general discount.

  • A self managed super fund. If you go the SMSF route, you’re well within your rights to add property development to your portfolio. However, there are a number of conditions that you have to satisfy.

The main stumbling block with SMSF property development is funding. Typically SMSFs can only borrow to acquire a single property, or asset. The borrowing can’t be used to improve or fundamentally change the property. However, your SMSF could own units via a unit trust, or shares in a company, that could undertake this development, and therefore obtain finance. This assumes the SMSF does not ‘control’ the unit trust or company.

The main benefit of an SMSF is its low tax environment. The primary deterrent is once the funds/profits are in your SMSF they are generally locked up until your retirement.

So, what’s the preferred structure? Generally we recommend a discretionary trust as landowner, and a discretionary trust as the developer. If there are multiple investors involved there could be slight variations to the scenario. But whichever property development structure you choose, it’s vital to make sure your landowning entity is  separated from your development entity.

Property development finance

Today’s tougher markets mean more stringent conditions for property development finance. Andrew Niven, property finance guru from Nivcorp Property Finance says that whilst the development finance market continues to undergo change, the major banks still have appetite to lend in this space.

It’s about ensuring the basics are accurately presented, and finding ways to mitigate the banks’ perceived risks, so they’ll be comfortable with the project,’ he says.  ‘For example, inexperience can largely be mitigated by a strong delivery team.

There is definitely a ‘flight to quality’ as far as the banks are concerned. They’re obviously likely to be more lenient towards proven developers, so if you fit that box this undoubtedly continues to be the cheapest and most reliable funding source available.  There is, however, only so much a bank can do on gearing and pre-sales.  This means funding solutions are increasingly hard for those who are new to the development game, or want something out of the box – such as flexible loan conditions, higher gearing or nil/low pre-sale.

Development finance has evolved considerably since 2016 and there is now a broad spectrum of lending options available.  Once we establish our client’s needs, we start with the banks and work our way through the line of second tier banks, credit unions, fund managers and private financiers, to find the most suitable and competitively priced option in the market.  Non-major financiers have and will continue to play a pivotal role in this space, and with new players regularly appearing, pricing is at the most competitive point we’ve seen.

 However, this largely unregulated market inevitably attracts opportunistic punters who quite frankly don’t know the risks involved in lending money.  It pays to know who you’re dealing with. The cheapest money in the market means nothing if it doesn’t show up, OR they suddenly want it back!

The current differentiators between the two primary sources of property development funding are as follows:

Banks/financial institutions

  • Banks are currently charging around 7.5% when taking into account line fees (charged on allocated capital).

  • The loan to value ratio (LVR) is up to 65% excluding GST.

  • They require a detailed understanding of your structuring. Today’s anti-money laundering laws demand in-depth scrutiny of the ultimate owners of your entities – the beneficiaries of any trusts, for example.

  • They also need a thorough knowledge of your sponsor/operator – including previous experience and other relevant factors.

  • You’ll have to provide a detailed feasibility study, including breakdown of the flow of funds.

Private lenders

  • Costs are currently around 12%. Depending on your requirements on gearing and pre-sale level costs, the range is generally between 12% -15%.

  • The LVR is higher than that of banks. Contingent on the deal/lender it could be as high as 100%.

  • Privates’ are better suited to site acquisitions and residual stock loans, whereas banks typically have a lower appetite.

  • The information requirements of private lenders are generally less onerous than those of banks.

  • Private lenders are happy to sit as your second mortgagee (or third), if there is sufficient equity in the project.

Lastly, it’s important to make sure that your funding is assigned to the correct entity. Funding for land acquisition and development/construction is often ‘lumped’ in as one. These should be completely separate.

Get in touch with M + H Private

Property development structure, feasibility and funding can be complex. To ensure you’re on track right from the beginning, contact the professionals at M + H Private in Brisbane on +61 7 3036 7174 today.

PropertySibylle Marxgut