Unless you’re one of a very privileged group of people and you do not need to seek Real Estate development finance, getting the cash you need is probably one of the most influential aspects of whether your real estate venture will succeed. That said, even if you don’t need to borrow money for a development, it usually makes business sense to borrow at least some of the cost anyway (that point is for a different article!).
Make no mistake, like all investment – real estate involves an element of risk to a lesser or greater degree. And like all businesses, risk should be managed. However, it could be said that ‘risk’ allows profit (or loss) to be made. If a real estate Investor or Developer has no appetite for risk, they may as well stuff their mattress with cash rather than putting it into Property. If there were no risk involved, wouldn’t everyone be a Property Speculator?
So it could be said that Risk is nothing to be intimidated by, but that it should be monitored so you don’t lose the shirt off your back (and with property, it’s possible to lose an awful lot of money in a short space of time if ridiculous mistakes are made). A philosophical attitude to this is quite important, because the truth of the current situation is that banks would really prefer the customer to shoulder as much of the business and project risk as possible. Let’s face it banks are in a powerful position, they have the money that the Developer wants…they call the shots. If you haven’t got the nerve to take on the risk, the bank will lend the money to another Developer who is prepared to take the risk.
I personally don’t think that this is a bad situation. It could be argued that the current/recent financial crisis who due in part, to excessive lending to people who should have been subject to greater scrutiny.
The 4 (very) basic rules to consider before approaching banks for Real Estate Development funding are:
1. Make sure you have access to people with experience! It is often said “never invest in anything you don’t truly understand”, if you are a novice Developer you should not be attempting to learn everything my your mistakes….they will be too costly. Speak to people with experience. The bank will insist upon you having good and regular access to appropriate professionals such as Architects, Structural Engineers, Realtors/Estate Agents or Building Surveyors.
2. Don’t expect to borrow too much against the project! As a general rule, a bank will expect you to put up at least 25% of the combined total of initial project purchase and build/development costs. You should also include a contingency fund of around 5-10% of the total build cost figure. It’s also a good idea to have enough working capital to be able to fund the initial stages of the individual build stages just until the bank releases funds in a staged-payment arrangement.
3. Don’t use a Limited Liability Company when you are starting out! The primary purpose of a LLC is to limit the personal risk of the company owner(s), this is not what the banks want to see. They will want to ‘facility’ to pursue you to recoup losses if it all goes wrong. This may sound dramatic, however I am talking worst-case-scenario! In reality, banks would far rather work with you to sort out problems than immediately enforcing their agreement covenants.
4. The CV of the individual Developer. When you begin to establish a good track-record in property development, the banks will tend to be far less nervous about lending you money. It’s never a good idea to take on a huge project that the banks knows will challenge you. It’s far better to gain experience by carrying out light work (such as modernisation and redecoration) rather looking for a substantial rebuilding project as one of your first attempts. ‘Easing yourself’ into the field of Property Development is the way all very successful professional developers have done it. It’s not a way of life that should be entered into on a whim; if a Developer gets in ‘above their head’, they are far less likely to continue in the field. Completing a Real Estate development is a very satisfying thing, it’s much more sensible to complete several ‘quick refurbishments’ than jumping straight into a substantial project requiring specialist structural work.
To conclude, banks are willing to lend at the moment. they have simply become more scrupulous with who they lend to. If you have prepared yourself properly to begin your venture (and you’re creditworthy), then you will find that the banks are far more likely to accommodate your requirements for Property Development Finance.