Development finance explained: TDC, presales and why the first deal is the hardest

Residential lending assesses you. Development finance assesses the project. That shift catches out a lot of experienced property investors doing their first small development, because everything they know about getting a loan approved suddenly applies to a different question.

The three ratios that size the facility

Lenders size a development facility against three constraints and lend to the lowest of them.

LVR — loan to value ratio. The loan against the end value of the completed project, usually the "gross realisation value" net of GST and selling costs. Bank appetite for residential development is commonly around 60–65% of net realisation.

LCR — loan to cost ratio. The loan against total development cost. Commonly around 75–80% at a bank.

TDC — total development cost. Land, construction, professional fees, council contributions, finance costs, marketing and selling costs, and contingency. This is the number that matters most, and it is the number first-time developers most consistently understate.

Because the facility is the lowest of these, your equity requirement is set by whichever bites hardest. On a project with strong margins, LCR usually binds. On a thin project, LVR does.

What you are expected to contribute

Typically 20–30% of total development cost, and the lender will usually want to see it spent first. Your equity goes in before the facility draws — a structure called "equity first", and it means the land purchase is generally funded from your own capital.

Land equity counts. If you have owned the site for a while and it has appreciated, the uplift can count toward your contribution, though many lenders will use the lower of cost or current valuation for a recently acquired site to prevent value being manufactured through a related-party sale.

Presales

For residential projects above a handful of units, banks generally want presale cover — qualifying unconditional contracts covering some proportion of the debt. Depending on the lender, the market and the project, that has historically ranged from around 60% to full debt cover, and it tightens when the market softens.

What makes a presale "qualifying" is narrower than people expect:

• Unconditional, with a deposit of usually at least 10%
• To genuinely unrelated purchasers — related-party sales are excluded or heavily discounted
• Within lender concentration limits, so one buyer taking six units may only count as one or two
• Often with a cap on the proportion of foreign purchasers

Presale requirements are the main reason developers go to non-bank and private lenders, who will frequently lend with reduced or nil presales in exchange for a materially higher rate. For a project with a strong margin and a short build, paying more to start twelve months earlier can be the right commercial trade. For a thin project, it is how the margin disappears.

How the money comes out

Progressively, against certified claims. The quantity surveyor is central to this: they certify the initial cost plan and then sign off each progress claim before the lender releases funds. You pay for the QS, and they work for the lender.

Two consequences that surprise first-timers:

You fund in arrears. The builder claims for work completed, the QS certifies, the lender pays. There is a gap of typically two to four weeks, and you need working capital to cover it.

Cost overruns are your problem. The facility is fixed at the cost plan. If the build runs over, the lender does not automatically increase the facility — you fund the overrun from equity, or you go back for a variation you may not get. This is why contingency is not optional, and why a fixed-price building contract with a reputable builder is worth more to your finance application than almost anything else you can do.

The interest nobody budgets for

Interest during construction is usually capitalised — added to the loan rather than paid monthly — which is convenient and easy to underestimate. On a $4m facility drawn progressively over an 18-month build at a double-digit private rate, capitalised interest and line fees can run to several hundred thousand dollars.

That figure belongs in your feasibility as a line item from day one. Along with:

• Establishment and line fees, often 1–2% of the facility
• QS fees, initial and per claim
• Legal costs, both sides
• Valuation, often more than once
• Exit or extension fees if the project runs long

Add them up and finance costs are frequently 8–12% of total development cost on a private facility. A feasibility that shows a 20% margin before finance costs is a very different project after them.

The six things that sink first applications

No relevant track record. The first development is the hardest to fund. Mitigate it by building a team with track record — an experienced builder, project manager and QS — and by starting small. Two townhouses before twenty.

An optimistic feasibility. Lenders test your numbers against their own valuer's assessment of end value and their QS's assessment of cost. If your feasibility is materially rosier than both, the credibility of everything else you submitted drops.

No contingency. Under 5% reads as inexperience. Most lenders want to see 5–10% depending on complexity, and more for a renovation or anything with unknowns below ground.

Unresolved planning. A facility on a site without development consent is a different, more expensive product. Get the DA — and check the conditions, because a consent with an expensive condition attached is not the same as a clean one.

Builder risk. A builder without the licensing, insurance, capacity and balance sheet to complete will stop an application regardless of how good the site is. Lenders check builders now in a way they did not a decade ago.

Weak or unproven exit. Every development facility is repaid by either sale or refinance to a term facility. The lender needs to believe in that exit. "We will sell them" is not an exit strategy; comparable sales evidence and a marketing plan is.

Where private credit fits

Non-bank and private construction lending is a large and legitimate part of this market. It is faster, more flexible on presales and track record, and considerably more expensive. Rates in the low-to-mid teens plus fees are common depending on position in the capital stack and the risk of the deal.

Used correctly it is a tool: it funds projects that are commercially sound but do not fit a bank credit policy, and the extra cost is bought with a shorter timeline. Used to rescue a project that does not work at bank rates, it accelerates the problem rather than solving it.

The discipline that keeps you out of trouble is unglamorous — build the feasibility with real numbers including every finance cost, stress test it with a 10% cost overrun and a 10% fall in end values, and only proceed if it still works. If the project only survives on the optimistic case, the finance structure is not the thing that needs fixing.

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General information only. This is not credit assistance or a recommendation and does not consider your objectives, financial situation or needs. Development lending criteria, LVR and presale requirements vary considerably by lender and market conditions. All lending is subject to assessment. To discuss a project, book a free consult.