It Pays to Prioritise Your Development Interest Budget

The elements of a project feasibility are simple—the market value of the product less the costs to acquire, develop and sell should result in a profitable outcome.

HoldenCAPITAL Partners’ principal Dan Holden believes many developers have a reasonable handle on these costs, but often don’t properly research the market and their projections are inaccurate when assessing a new project.

They then find themselves fine tuning their submission to improve the bottom line to qualify for suitable funding.

“For example, recently we were seeing builders looking to pass on rapidly rising material costs combined with supply delays which for those developers still in the process of preparing their feasibility has been challenging” Holden said.

“More recently we are hearing those costs are stabilising but there is evidence of rising labour costs and shortages of manpower in some trades so there is continuing pressure on the margin in new projects.

“It’s important to have an appropriate level of ‘fat’ in a new deal and maybe a little extra when you see these types of pressures at play.”

Holden believes that rookies and even experienced developers often overlook the importance of the project interest allowance and the actual method by which interest is charged is worthy of analysis.

In addition to site acquisition and residual stock loans, HoldenCAPITAL Partners provide construction facilities (from $2 million to $15 million).

More recently it has identified that in some instances there are cost benefits to be considered by structuring loans with an interest rate charged on the loan amount (straight interest rate), rather than the combination of an interest rate charged on drawn funds and line fee charged on the facility limit (combination rate), commonly applied by many non-bank lenders.

“It is very much dependant on the project and how the monies will be advanced as well as the term of the loan that will determine which option best suits the developer’s needs,” Holden said.

For example, compare feasibilities to develop four townhouses with no presales, an assumed six to seven months construction period with a relatively standard drawdown profile or ‘S-curve’ and immediate repayment on completion.

The differing interest costs from applying a 7.25 per cent straight interest rate compared with a combination rate of 7.25 per cent and 2 per cent line fee respectively are relatively similar with the combination rate marginally less expensive.

However, this quickly changes where the construction doesn’t go to plan and runs behind schedule, or the stock sales are slow and more time is required to achieve sales to reduce the loan.

From experience, Holden said that “often the sales rate can slow during construction before picking up again on completion”.

“this means that if the loan is likely to have an extended period where the full combination rate of 9.25 per cent (7.25 per cent interest rate and 2 per cent line fee), is in play, the gap quickly starts to widen in favour of the straight interest rate of 7.25 per cent.”

Holden said developers need to plan ahead for any extended construction or selling periods and model the impact on interest and other holding costs so that they can select the funding options that give them their best possible outcome balanced with flexibility to meet changing market conditions.

HoldenCAPITAL Partners targets site acquisition and residual stock loans on Australia’s eastern seaboard, and more recently construction facilities have focussed predominantly on small housing and townhouse projects, and well-located land subdivisions.

For borrowers interested in HoldenCAPITAL Partners’ lending options, you can find out more here.

For investors interested in joining HoldenCAPITAL Partners’ investor group, you can register here.

Main image: 18 town house projects recently funded by HoldenCAPITAL Partners.

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