Okay, couple of questions for the mortgage men (and ladies)
I intend to buy a block of land, say worth 600k, and build a detached duplex (ie 2 townhouses) on it. Cost to build 400k. Total cost 1 million Sale price would probably be about 650 apiece. Profit about 300 grand.
I am currently leaning towards buying the property as a company, which would allow other investors to purchase shares, and raise some money this way.
I also have cash equity to put in
Thirdly, I would be trying to get some form of VF from the vendor.
My understanding is that banks will happily lend to companies (without personal guarranties), if the numbers fit. I have heard the figure of 70% lend by banks, but does this mean that I would need to raise 30% of 600k for just the block, or 30% of 1Mil for the entire development?
Also, will VF be viewed much differently from cash? Example, how much different would 200k cash and 200k VF be viewed from 100k cash and 300k equity?
Any other bright ideas?
Also, if I bought the block, how does the basic structure of a JV (with a builder) work?
All help much appreciated[thumbsupanim]
Hi Wrappack,
Unless you take out a construction loan you may have problems with the raising of capital. Initially the security you will have to offer a bank is a block of land only. As a commercial loan, you only be able to borrow between 60-70% (depending on bank) of the purchase price UNLESS you have another security. This means you would have to come up with the cost of construction plus the extra 30 or 40% plus costs.
As far as a JV with a builder is concerned, the viability of this will come down to whether it is possible or not for one of you to provide an additional security, and your current debt positions which will also be taken into account.
I would need more information to advise.Regards
Depending on location, it may be possible to get 100% finance of these types of deals on the one security.
There are lenders that will lend 70% of end value. In this case, if they value up at $1,300,000. You could borrow up to $910,000.
But you will have to supply a personal guarrantee. offhand, I do not know of any lender that will lend to a company without a personal guarrantee.
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
It would appear you intend selling the townhouses – with an estimated valuation of ~$1.3MM. Therefore, pre-sales [OTP = off the plans] may be an option to consider.
A personal guarantee is not necessarily required if selling OTP. In this case, primary lenders will often loan 70 percent [sometimes up to 80%] of the estimated valuation i.e. land + improvements – a [reputable] quantity surveyors report is required.
If a personal guarantee is not utilized, the lender will require a note over the land, and the “pre-sale” of at least one townhouse [in this case].
At 70 percent this may enable you to raise ~$910,000 [@ $1.3MM valuation] – although $400,000 appears low to construct two townhouses of a reasonable size and standard in today’s market – subject to location.
A secondary [mezzanine] lender can be introduced to secure 100 percent financing [subordinate note to primary lender] however, they will likely require the sale of both townhouses OTP – or a personal guarantee as security. The interest rate can work out at more than twice that of a primary lenders i.e. incl. origination fees, etc.
In terms of how much capital you require, the key to real estate development is “controling” land – not necessarily acquiring it. Therefore an upfront $600,000 outlay for land may not be the only course of action.
An option may be negotiated with the land owner whereby a refundable deposit is paid, and settlement is subject to meeting the minimum sales target, for example – which will satisfy the primary lenders requirements.
Or you may enter a joint venture arrangement with the land owner, where he/she receives a higher valuation in exchange for deferred payment i.e. when the townhouses are sold.
Personally, I would not encourage a joint venture with a builder because this is not often a value-add, where the land owner offers a tangible asset which can be used as equity.
A joint venture agreement is subject to many factors and should not be structured without qualified legal advise.
In summary, if you decide to sell OTP, the cost can be limited to preliminary costs – most of which are required before a bank/primary lender will consider a loan, including; research/feasibility, legal, planning, design and marketing – and land deposit if required.
If you intend retaining the townhouses, then you will require either a secured loan, or sufficient capital investment to satisfy the preliminary costs and primary lenders criteria.
— Michael
P.S. Vendor financing is in effect the same as cash/equity – but it must be secured by a note or other guarantee, as prepared by legal counsel.
Oops, my mistake, when I said block of land, I really meant block of land with a crappy just rentable house till the da is passed and the bulldozer flattens it. Would I still be needing a construction loan, or just a normal loan now?
Once again, I have had to reread the posts multiple times to fully understand the width, breadth and knowledge contained within. The indepth wisdom of minutii and esoterics of the property game is both infinite and indispensible!
Looking down the road a few years, I would prefer to be retaining most (if not all) the duplexes, and using revaluations to be a good source of cheap finance, no tax paid (prior to selling) Thus, I am more inclined to try to set up systems to minimise OTP sales, even if I wind up with less profit (ie shared with JV, etc).
Terry, what sort of interest rate would I be paying on 70% of end value? What about 60% (any cheaper?)
If VF is treated the same as cash , surely this is the easiest and cheapest way to get finance, (even if it was only 5-20% of the purchase price)
What do you think of the basic premise of buying the asset in a company, and then allowing other investors to invest in the company? Is this way preferable to mezzanine finance? How would they differ? If no one was interested, I could still proceed as before, (but would probably delay plans for 2-3years)
Wrappack. It would be about 10 to 12%
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terry, is that 10-12 % on the whole amount, (borrowed in stages according to the building), or is there a standard variable rate, and then you pay 10-12% on the building costs. (clutching at straws here, and I think I know what your reply will be!)
[WP] What do you think of the basic premise of buying the asset in a company, and then allowing other investors to invest in the company?
— Before setting up a company with the intention of raising capital, put yourself in the prospective investors position.
Investors will focus on several qualifying factors, including; assets [not necessarily tangible], you and your teams experience, prior success, market factors, risk, exit strategy, and comparable opportunities i.e. $1-2MM residential development in other locations.
If these questions stack up, then the investor will look at the rate of return – whether the projections are realistic, what contingencies are in place, etc.
I do not wish to discount this method of raising funds, but there are a number of factors you need to consider before moving forward – which can save you time and money.
In terms of whether setting up a company and targeting investors is a preferential option, I would recommend speaking with qualified financial and legal advisors.
It costs money to make money. Failed developments are often managed by those who try and cut corners during the early stages.
[WP] “Is this way preferable to mezzanine finance? How would they differ?”
— You often need to setup a corporate entity [company/trust] in order to secure mezzanine finance for a real estate development. However, mezzanine finance follows a primary loan – first note over the land or other security, mezzanine being “second”.
Before securing a primary loan, you need to complete a preliminary phase – at a cost [as noted in my earlier response]. Banks/lenders will not finance a development, no matter how large or small, based on the idea alone.
[WP] “If VF is treated the same as cash, surely this is the easiest and cheapest way to get finance”
— More than often if the development is feasible, the “easiest and cheapest” method of obtaining finance is an institutional lender. Savvy vendors will take a similar approach to private investors.
— Micheal
wrappack,
We’ve looked into this recently (not for property, for other investment types), both via forming a Unit Trust and issuing units & via an unlisted corporation.
In both cases there are a number of ASIC hoops & rules that must be negotiated.
Please do NOT attempt to do this without consulting with ASIC, with a lawyer & with an accountant.
It’s worth starting with a read through the relevent sections in the Corporations Act.
Cheers,
Aceyducey
Talked to dad re this (a chartered accountant), who said
i) unit trusts-good if you are sure of raising the money (about 10M+). Cant easily raise additional money. Hopeless for my situation.ii) Unlisted company. Easy and cheap to set up, can add cash, use for interest, architect plans, etc. Asset could be revalued after da passes, and shares sold to other people. This would not be a public offer or an ‘add in the paper’, but people that I know, some of whom have expressed some interest in the concept. Company can be agreed to be wound up at a certain point in time, or shares bought.
iii) problem is in valuing the block, and best way is to see what you can sell/value the duplexes at, then subtract what they will cost, subtract the profit margin and interest, and make sure that the block is priced cheaper than that. And I cant yet crunch the numbers because I am only part way through my feasability study (but the gaps in my knowledge are closing!)
Then, decide which way to proceed.
Michael, when you say to use an institutional lender, are you referring to mezzanine finance to make up the gap in which banks will lend?
Option [ii] may work. However, issuing shares is not always the best option.
Consider what you want the company to achieve in the future, and not just this one project.
If the project is conducted under your company name and is a success, you have established “equity” in the brand [company name] which can have a value attached.
The more successful the company, the more value is added to the brand. [this is one example of adding value in addition to profits]
If the investors exit on completing the first project, they are compensated for brand equity and other factors which increase the value of your company, in addition to a share of profits.
Furthermore, in addition to considering the future role of the company, your objective should be to limit your personal liability and maximize control/profitability.
If a shareholder does not meet expectations, or a financial committment for example, this can compromise the project and increase your liability – or worse case scenario, bankrupt the company.
Therefore, other options in terms of “structure” should be considered – and discussed with the appropriate legal and financial advisors – such as raising money under a partnership which invests in your project and can be dissolved when the project is completed.
Your company “XYZ” [you as sole shareholder] then conducts the project under contract with the partnership. XYZ retains an interest i.e. shares/units in the partnership to offset contribution/risk, etc.
The above example may not reduce your liability in the first project, but it will enable you to retain control of your company, and benefit from its ongoing success.
In response to your question, correct – a mezzanine lender bridges the gap between the capital you have invested and the primary lender.
— Michael
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