Your Mortgage Developing Your Game
Peter Norris outlines a game plan for wannabe developers and discusses the risks.
1 January 2016
Recently, 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 despite their earlier success holding property, they have no idea where to begin with trading. More specifically, 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?
End Game
You must make sure your strategy still works if things go wrong – and things do go wrong. We’re already seeing developers stuck in over-leveraged positions in South Auckland because of the property market slow-down and changes to LVR rules. Liquidity is almost always underestimated when the market slows down.
American author and businessman Stephen Covey once said “Begin with the end in mind” – a statement which couldn’t be truer in property development. Understanding your strategy for each project is pivotal and will have a significant effect on the outcome.
Too many people get Started and refuse to pay The experts to get property Ownership or borrowing Entities structured Correctly
Expert Team
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; to be fair, any less may not be worth the risk. If 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 find people who do. People like project managers, quantity surveyors, valuers, accountants and mortgage brokers are key people who should be on your team.
Get your structure right from the start. Too many people who start 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.
It’s important to get advice and minimise any risk 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’.
Plan Ahead
It would be easy to conclude that property traders and developers are not a bank’s favourite customer, often because the customer has not presented themselves or the project well enough to the lender.
The more work you can do on your finance proposal and especially on mitigating risk, the more appealing you become to the lender. Sometimes a project, regardless of your planning, won’t go the way you thought it 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 reserve; always split your banking over multiple lenders.It is smart to predetermine “trigger events” and have a plan for every eventuality. Most of all don’t procrastinate and don’t be greedy. Successful property development – like increasing prices is mostly market based. This means it’s easy to be caught 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 is apt.
