Construction Finance – Understanding How Funders Price for Risk

As developers turn to new sources of capital for funding their construction projects, it’s important to understand how the various funders are pricing for risk.

The major banks in Australia have taken the approach to increase hurdles for developers vs pricing for risk.  As an option, banks could increase interest rates and only consider quality projects at slightly higher LVR’s and/or lower pre-sale hurdles.  Instead they are raising the equity requirements of developers and significantly increasing pre-sale hurdles making bank finance commercially unfeasible for many.

How Private Funders Price for Risk

Enter the private funding market or “shadow banks” who are pricing for risk and helping developers progress and complete projects.

The table shows how various funding is priced for risk and the parameters developers can expect.

ProductBankNon-BankNon Bank  >6MMezannineCorp Pref Equity
Interest RateBBSY + 2.5% + 1.5% Line9.95%11% – 14%15% – 20%15% – 17%
Fees0.5%1% – 2%1% – 2%2% – 4%3%
LVR TDC70%80%80%85%50% of levered equity
LVR GRV60% on comp65% on comp65% on comp75% on compN/A
LVR Land Bank35% on land only65% on land only35% on land only70% land bankN/A

Why Developers Would Pay More For Funding

As you can see from the table above, private funding costs can differ significantly, however the price differential is offset by other benefits for developers.  These include, lower pre-sale hurdles and higher loan ratios.  Developers can add to this, the commercial benefits that are delivered speed to approval and subsequently to market.

Private Funding and Pricing For Risk Benefits In Real Life

A clear example of how paying more for finance can have strong commercial outcomes is clear in a recent transaction facilitated by DFP.  A developer client needed private funding for a quality project in Chermside Brisbane. DFP structured a finance solution providing a mix of Bank debt and mezzanine funding.

The result for the client was an LVR of 90% on a total loan of $12.2 million.  

If you are interested in looking at alternative funding sources to achieve strong commercial outcomes for your projects working with an expert in private development funding, such as DFP can make all the difference to getting your project started.

The Urban Developer is proud to partner with Development Finance Partners to deliver this article to you. In doing so, we can continue to publish our free daily news, information, insights and opinion to you, our valued readers.

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