Construction finance is a specialised form of borrowing that can be more difficult to arrange yourself, especially through a traditional lender. Traditional lenders like banks are risk averse, and they are likely to be even more so in a post-COVID 19 economy.
However, arranging constructions loans is one of our specialties at DFS, especially for property developers and owner builders. We are private lending specialists.
Read on to find out how construction finance works and the types of projects we finance for our clients.
How does construction finance work?
Construction finance helps you to fund building and development projects. The crucial first step in the construction finance process is to accurately calculate the total amount of funds you need.
After all, the last thing you want is to not have enough approved finance to complete your project. Knowing that you have will give you peace of mind even before the building process gets under way.
Construction projects consist of both ‘hard’ costs and ‘soft’ costs. Hard costs are your actual building costs (e.g. materials and labour). Soft costs on the other hand include all of your other associated (but equally essential) costs like:
- council permits.
- architect plans.
- professional inspections and approvals (e.g. engineers).
It’s important that you factor in all of your costs when you apply for construction finance. It’s also important to factor in an amount for contingencies in case you have any hiccups or cost blowouts during the building process.
Two essential ratios to calculate in planning your construction finance are the:
- loan to cost ratio (LCR)
- loan to value ratio (LVR).
Both of these ratios are influenced by the amount of deposit you can provide for your finance. Different lenders will have different maximum LCR and LVRs that they are prepared to accept on a construction loan application.
Loan to cost ratio
The LCR is the amount of finance you need expressed as a percentage of your total construction costs.
A developer can provide a deposit of $250,000 and needs to borrow $1 million to cover total construction costs of $1.25 million. The LCR is 80% (calculated by dividing the loan amount of $1 million by the total building costs of $1.25 million).
Loan to value ratio
The LVR is the amount of finance you need expressed as a percentage of the total forecast value of your project when it is completed.
If you are a savvy property developer, the forecast value of your construction project upon completion will be far more than your total construction costs. However, it’s important to be realistic in your forecast valuation, and your lender will typically get an independent, conservative valuation before approving your construction loan.
A developer can provide a deposit of $250,000 and needs to borrow $1 million to cover total construction costs of $1.25 million. The project is independently forecast to be worth $2 million on completion. The LVR is 50% (calculated by dividing the loan amount of $1 million by the forecast development value on completion of $2 million).
Managing your construction finance repayments
An effective way to manage your construction loan repayments is to arrange for a progressive drawdown of your approved finance. A progressive drawdown is a gradual release of your funds.
For example, you’re unlikely to need all of your approved construction finance upfront, so your loan contract can be structured so that you receive funds progressively as required (e.g. during specific stages of the construction process). Doing that helps you to avoid paying interest on the the entire amount of your loan upfront, lowering your repayments during the early building stages.
If you’re building a multi-residential development like a unit/apartment or townhouse complex, you might also be able to sell ‘off the plan’ to make financing your project easier.
What construction projects does DFS finance?
We can arrange construction finance for a diverse range of projects, including:
- new multi-residential development projects.
- new commercial property developments.
- new single dwelling residential homes.
- commercial property renovations.
- residential property renovations.
How can I get the best construction finance terms and conditions?
You should try to provide:
1) as much deposit as you can afford.
2) as much lender security as possible. First mortgages are the preferred form of security for most lenders.