The challenges facing property developers in the current market

Post by Matt Evans - Property Finance Manager

Property development has been a lucrative gig over the last few years – seen by many as a great way to build wealth (although one that’s not without its risks).

But recent changes in the market have brought about new challenges. With sales prices down and construction prices up, it’s a bit of a perfect storm with the potential to cause real headaches for both budding and experienced developers alike.

If you’re looking to embark on a development project any time soon, here are the key challenges you need to keep in mind in the current environment.

1. Generating pre-sales

The majority of lenders (not all) require some form of pre-sales.

A few years back, before the market took a nose-dive, selling off-plan was a breeze – and that made development projects much more attractive to lenders. But these days, developers are finding themselves having to compete with a huge oversupply of completed stock on the market, meaning pre-sales can be harder to come by.

You don’t want to get caught in a race to the bottom, so it’s important to find a way to add value for potential purchasers. This usually requires plenty of research, building a good level of understanding about your target market – first home buyers, investors, or down-sizers – then designing your product with what they want in mind.

Another great way to generate pre-sales is by using firms such as Enable Me who specialise in this stuff. You’ll pay more to use them, but it could mean getting your project underway sooner and being able to secure cheaper funding.

2. Getting the right builder & others professionals on board

A key part of minimising development risk in the current market is making sure the professionals you’re partnering with on your development are high-quality.

A lot of builders are doing it tough at the moment. There’s less work out there, as consumers tighten their belts on luxuries such as renovations, new builds and property development – so cashflows are tight.

This makes it crucial to be doing full due diligence, to give yourself a fair degree of certainty both that your builder is going to do a good job, and that there’s no cause for concern that they might go under during the project.

There are other professionals you can employ to help mitigate risk throughout the development, and hold builders and other subcontractors to account:

Quantity Surveyor (QS):

Some lenders require you to get a QS for the project, some don’t. There can be a significant cost associated with this, however there’s also significant benefit.

The QS undertakes analysis of the entire project, assessing risk, checking whether costs are reasonable and making sure the build is being managed efficiently. They can be worth their weight in gold if anything goes wrong throughout the project, helping you to manage that process with your lender.

Project Manager:

If you’re new developer, undertaking a large development with lots of moving parts, running a cost plus build model, or you just don’t have the time to manage the project in detail, then you might want to consider getting an experienced project manager on board.

They can be a really useful resource, helping to make sure trades are there when required and that the build is proceeding in line with expected the timeframe

3. Finance costs

Stories about the fall-out from high interest rates are all over the news at the moment, and unfortunately the impact isn’t just limited to home loans.

As the Reserve Bank hikes the OCR to combat inflation, investors behind development lending companies want to see greater returns on their money as well – to reflect the higher level of risk involved in funding development loans in this environment.

Whether you get project funding through a bank or non-bank, financing costs are creating challenges for developers right now, significantly impacting project feasibilities.

There are a few different components to development finance costs, and it’s important to understand how they work:

• Interest rate (per annum): the fee charged only on the amount drawn down at any one point. For example, if you have a loan limit of $1 million, and you’ve drawn down $200,000, you pay interest on the $200,000.
• Line fee: the fee charged on the total limit of your loan, for the duration of your loan. Essentially you’re paying for the lender to hold those funds aside for you while you’re not using them. It’s important to note that some lenders charge line fees on a monthly basis (i.e. 0.25% per month or 3% when annualised) and others per annum (i.e. 1.5% per annum). Make sure you factor that into your decision making process.
• Establishment fee: lenders will also charge a one-off fee of between 1% - 3% for development finance and this is normally added to the loan.

Navigating the offerings of different lenders, both banks & non-banks, can be tricky – which is why it’s so important to have the right advisers working with you on your developments.

For advice on your next project, get in touch today to arrange a chat with one of our property development experts.

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