Have you ever thought about commercial lending?

development-finance

This morning The Advisor referenced a speech that Vow’s general manager Leighton King gave at their mini-conference for brokers in Sydney last week. Leighton compared the surge that the third-party channel has experienced in business off the recent housing boom to the oil crisis in Russia and Saudi Arabia, quoting, “Russia and Saudia Arabia will go bankrupt … because they relied on one source of income and didn’t diversify.”

I think it’s a bit of a stretch to make any sort comparison of the broking industry to oil in Russia and Saudia Arabia! This once again highlights what I have been saying for months about aggregators banging on about this message of diversifying your product offering. I have made my beliefs pretty well known on this topic here.

To summarize, I disagree that brokers need to look towards things like life insurance and providing financial advice as ways to diversify. Instead I believe that brokers should stay within the specialist area of finance and look towards things such as asset and commercial finance in order to pick up different streams of revenue.

I will leave asset finance alone for another day so this post will seek to give you an introduction to commercial finance as I think it is a very exciting area of finance and something you will enjoy immensely the more you do it.



What is commercial finance?

When it comes to commercial finance I’m talking about things such as purchasing an office or warehouse, providing finance for a development or cash flow lending to a business. Today I want to talk specifically about development finance because for me, it’s by far the most interesting type of commercial finance.

For development finance there are a three distinct factors you need to be aware of. This will also serve you as a good way to explain to a client what development finance is if you ever come across a first time developer (there has been a lot over the past two years).



1. Fees

Although I think it’s obvious, one thing that clients need to understand is that the fees for development finance are significantly higher than residential. You’d be surprised how many clients do not understand this so it’s really important to educate first time developers about this right at the start so there are no surprises.

First up, the lender will generally charge 1% upfront for the deal. What happens is that they will divide this fee up 50/50 with yourself as opposed to the residential model of providing you with a straight commission. This means that with development finance it’s essentially a fee for service offering. The bank will tell you that if you want, they need to charge 0.5% to cover their cost so if you’re happy to go to the client and charge them a fee direct, that is fine to. However, the way most brokers do it is just to tell the client that the fee is 1%.

Where development finance also differs is that it is the client’s responsibility to cover the cost of the bank’s valuation and legal fees. The cost of either of these fees will vary enormously depending on the development but as a rough guide, for a small development i.e. construction of small unit block you’re looking at around $5,000 for each.



2. No strict servicing requirements

If you’ve brokered an off-the-plan purchase before and you’ve wondered why the Contract of Sale usually dictates a 14 day settlement period after occupancy has been issued, the reason for this is due to the fact that the developer usually needs to pay back their lender for what they used to fund the build.

For a typical development, the sponsor (jargon for owner of the site) and the lender are both looking for a 20% profit margin for the deal to be worthwhile. Most developers will simply look to make a profit out of the development and use a portion to fund their next one. They may end up keeping one or two units but developers are not typically buy and hold investors.

For this reason, because the loan will be paid out once all the units have settled, lenders do not have strict serviceability criteria for the sponsor to have to go through. Sure they’ll ask for the financials and background of the sponsor to get an idea of how credit worthy they are but there is no serviceability calculator as such that you will need you to fill out to get the approval.

Development finance largely comes down to the feasibility report the sponsor has completed and whether this stacks up from the lender’s point of view.



3. Valuations are similar to construction loans

You’ll know from doing constructions loans that the lender will complete an “as if complete” valuation on the land and will base their LVR off what they think the combined value of the land and building will be worth upon completion. This holds true for development finance except the term they use is GRV or Gross Realization Value.

This is another key factor behind whether or not a lender will provide finance or not.

For developers cash flow is king so they want the lender to contribute as much money as possible to the development. From a lender’s point of view, they want to see that the developer has as much skin in the game as possible in case the development goes sideways so often times a brokers ability to manage these two issues plays a major part in the development going ahead.

As a general rule of thumb, lenders will either allow a max of 60% of GRV or have a requirement that pre-sales needs to cover the lenders’s debt coverage.

So there you go, I know it’s a very brief introduction to what a development is but I’m hoping it’s enough for you not to be scared off by putting this type of finance in the too hard basket. With a little bit if effort you could see a whole new type of client open up should you decide to pursue this type of finance further.

Committed to your success,

Tim Russell

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