Getting your investment structure right
Over the last 3 weeks I have been approached by a number of existing ‘buy and hold’ investors wanting to change their strategy. They want to start trading and developing property. But, what has become apparent is that despite their earlier success holding property, they have no idea where to begin when trading. In particular, they have no idea how banks view traders and developers.
When starting out as a Developer what do you need to be aware of when applying for funding? What are the key things banks or non bank lenders are looking for? How do banks view Developers? And importantly, what are the risks when things don’t work out?You must make sure your strategy still works if things go wrong! And things do go wrong.
We’re already seeing developers stuck with over leveraged positions in South Auckland due to the slow down and change in LVR rules. Liquidity is almost always under-estimated when property markets slow down. Stephen Covey said “begin with the end in mind”. That statement couldn’t be truer for property development. Understanding your strategy for each project is pivotal and will have a significant effect on the outcome. Banks expect you to know your numbers. They want to understand your profit margin, and that you have enough contingency to absorb the likely shocks and surprises along the way. Typically, banks are looking for a 15-20% margin, and to be fair, any less than that may not be worth the risk. I
f you’re starting out on your first development, then chances are you won't have the knowledge or experience to put these projects together. Pull in experts and expect to pay for it. Banks put a lot of emphasis on experience so if you don’t have it pull in people that do. People like project managers, quantity surveyors, valuers, accountants and mortgage brokers are all key people that should be on your team. Get your structure right from the start. Too many people get started and refuse to pay the experts to get property ownership or borrowing entities structured correctly, only for that to become an expensive nightmare as an Accountant tries to unravel the mess. Tainting and paying tax is inevitable these days but it's still important to get advice and minimize any risks to other properties you own.
Depending on the role you take in your projects, you may or may not be able to protect your existing properties from ‘tainting’. It would be easy to conclude that property traders and developers are not a banks favourite customer. More often than not, this is due to the customers not presenting themselves or the project well enough to the lender. The more work you can do on your finance proposal and especially mitigating the risks, the more appealing you become to the lender. Sometimes projects, regardless of your planning won't go the way you thought they would. That’s where planning different scenarios becomes useful. Always get money well before you need it. Take out the uncertainty.
For example, sell a property before you need to sell it. Borrow extra when you can, not when you need it. Always keep money in reserves, always split your banking over multiple lenders. Have predetermined trigger events and have a plan for every eventuality. Most of all don’t procrastinate and don’t get greedy. So much of what makes property development successful is market based – like increasing prices. That means it's also easy to catch yourself out when things change quickly. When you’re in development and things don’t work out, that’s just business. But you can expect some fairly brutal conversations with your lender. When it comes to developers, banks will not give out too much rope and won't be overly sympathetic. The expression to live and die by the sword seems apt.