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Property Development: Bank Funding Vs Private Lenders


Time Is Money

The most precious commodity on earth and one we often take for granted is time. Between our arrival and departure of this world, we aim to get as much done as possible. In this article, we will demonstrate to you, how you can save more time, make more money, and have less stress!

Private Lending Is Cheaper Than Bank Funding

Property Development Funding

I will make this bold statement, that private lending is in fact cheaper than bank funding if you’re in business or property development, with short to medium term capital requirements!

Firstly lets make one thing clear! I am not a bank hater, I think they have an important role to play in consumer lending and long term business lending. CBA has done a great job for the consumer market, Westpac and NAB have helped businesses, and Macquarie is creating its own niche in specialised business areas. They are good for carrying long term debt, either for consumers or businesses.

Immediate and Urgent Funding

However their ability to service immediate to medium term funding requirements of businesses, isn’t great. They are especially terrible for businesses, builders or property developers that require funds quickly, to go in and out of projects or purchases, who also need to recycle money quickly to move into other projects whilst reinvesting profits. o

Banks Cost Less, But Have The Highest Opportunity Cost

The Costs Of Bank Funding

Firstly lets define what is opportunity cost.

“In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone where, given limited resources, a choice needs to be made between several mutually exclusive alternatives. Assuming the best choice is made, it is the "cost" incurred by not enjoying the benefit that would have been had by taking the second best available choice”

The reality is that bank funding presents the lowest cost of capital. Always has, and always will. But it will never be as commercial, as fast, as flexible nor as aligned as private lending for commercial transactions / short term business borrowing!

On face value it represents the lowest cost of capital and it is the first preference choice of most people. But it has a very high opportunity Cost!

The Issues With Banks For Short Term Business Funding.

A Low Cost of Capital Requires A Low Credit Risk Profile

In order for the banks to provide you with a low cost of capital, they have to ensure that you represent the lowest credit risk profile. So, they must see the colour of your underwear and everything else in between!

In order to do all this, they must ask for your business financials, liabilities, check your serviceability, see your personal assets, check your credit score, check your credit card debt, and see your personal living expenses.

By the time the credit committee / risk department has had time to 81do all this and ask you a million questions, an easy three months has passed before you can be provided with the funds you need.

That three months, has a cost, which we will discuss later!

Principal And Interest Repayments

Firstly, most bank repayments are principal and interest, and if its interest only, its usually for a limited amount of time. Whilst banks may capitalize interest repayments on construction funding, the terms change when a property developer or investor requires funding for site acquisition. Most builders, property developers and business owners that require funding for short to medium term loans, typically want an interest only repayment.

Site Acquisition Funding And Settlement Risk

If you’re a property developer or property investor, or just in business generally, and you need to settle quickly. There is no guarantee that a bank can settle on time, as the credit team does all their necessary DD. We’ve had clients who had their business loans worked on for 3 months, and still their bank failed to settle on time, costing the client tens of thousands of dollars in penalties.

Bank Funding Has A Bandwidth Tax When You Need Funds Urgently

Imagine being a builder, property developer, property investor or just a business requiring urgent funds for your expansion. Even if you give the bank its necessary notice period, there is no guarantee that they will approve you.

And here is the problem!

There is a very good research done on how scarcity and uncertainty, takes up bandwidth in the human brain! The book scarcity covers this concept perfectly, and you can read more on it here. Basically, by being occupied with scarcity or an issue, we are unable to effectively operate in other areas of our lives. If a bank takes three months to approve something, that is three months of your energy, thinking bandwidth and time, that could have been applied elsewhere that could also generate a dollar return.

Bank Funding For Property Developers And Builders

When it comes to property development, most builders and property developers find it very hard to deal with banks.

Firstly, the banks have high presale requirements for property development. Not only do the banks want to take a security position over the project, but also any other assets the developer might have.

Secondly a lot of banks don’t like funding builders. Some have avoided the construction industry all together, because very few builders can show a constant stream of income.

Bank Funding Requires High Presales In Construction Lending

Presales aren’t a property developers’ best friend.

Firstly, most presales are done at a discount, not full price. So, a loss is incurred there against future value.

Secondly in an environment where the cost to build is rising, against a ceiling price on the sale price of pre-sold stock, another loss is incurred by the property developer.

Thirdly, a loss is made in the time it takes to achieve a high ratio of presales, in order to get construction funding from a bank.

Think holding costs and financing costs during this time!

Even if you owned the land outright, you must waste precious time, to get those presales before you could even dig a hole in the ground.

The True Costs Of Bank Funding For Property Development?

Besides the low interest rate there are opportunity costs for builders and property developers using bank funding versus private lending.

What Are The Realities of Bank Funding?

  1. The time it takes to get approved and funded for a typical loan for site acquisition is 2 to 3 months.
  2. The time it takes to achieve debt cover ratios for presales for construction funding, is typically 3 to 5 months.
  3. Lost profits on compulsory presales in a rising cost environment.
  4. Lost profits on a high ratio of compulsory presales compared to if sold on completion.
  5. The bandwidth tax in being preoccupied with funding uncertainty, when that energy could be focused on other productive endeavours.
  6. The most important loss though is time, and we can roughly quantify that. Lets say it took only 4 months on average for development funding / construction funding. If you are in the game of development (developing then selling all stock) , and you had to do that 4 times. You’d effectively lose 16 months in waiting for financing.

The Opportunity Cost of Selecting Bank Funding Vs A Private Lender

  1. Approval and delivery of funds for site acquisition is usually 1 to 3 weeks. That is a saving of at least 2 months.
  2. Presales requirements for construction funding are zero or far lower than a bank (about half). So time saved here is at least 3 months.
  3. If a bank requires 10 presales, and a private lender only requires 5. In a rising cost environment, how much profit loss are you incurring on the extra 5 or 10 sold at a fixed presale price, vs zero or only 5 with a private lender? Taking into consideration the higher cost of capital with the private lender.
  4. If a bank requires 10 presales, and a private lender only requires zero or 5, what is the delta in profit loss vs had you sold the other 5 or 10 at full price? Taking into consideration the higher cost of capital with a private lender.
  5. Given you have a greater certainty of funding with a private lender. How much better off are you mentally, to focus your endeavours on other matters, and what is the dollar return from that?
  6. If you had done 4 projects with a bank, and by the time you got funding, it took a total of 16 months in aggregate to get shovel to ground vs 8 months with a private lender. That 8 months and reinvestment of profits, what does that look like dollar wise? Taking into consideration the higher cost of capital with a private lender.

Private Lenders And Property Development Funding

Taking all of the above into consideration and given the numbers I have looked at, property developers , builders and businesses are better off with a private lender, where capital is required quickly and on a turn over basis over the medium term.

Bank funding is best suited when a project is complete, and any residual debt is refinanced with a bank at a lower cost. This in turns allows a significant yield to be made via property rental returns over the cost of capital with a bank.

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