What is loan to cost in development finance?

Total development cost includes the land at its purchase price or current value if held for a long time, construction under the building contract, consultants such as architects, engineers, surveyors and town planners, council and authority contributions, legal and finance costs, the quantity surveyor, marketing and selling costs where the lender includes them, interest capitalised over the loan term, and contingency. GST is generally excluded because it is recoverable. Lenders will check every line against the feasibility and the QS report.

A lender might offer 70 per cent of cost and 65 per cent of the gross realisation value, which is the end value of all the completed stock net of GST. On a project costing $5,000,000 with an end value of $6,500,000, 70 per cent of cost is $3,500,000 and 65 per cent of value is $4,225,000, so the loan is $3,500,000. On a thinner project costing $5,000,000 with an end value of $5,500,000, 65 per cent of value is $3,575,000, which now limits the loan even though 70 per cent of cost would allow $3,500,000. The tighter the margin, the more the value test bites.

The developer's equity is the cost not funded by the lender. It is contributed first: land equity, cash spent on consultants and approvals before the loan, and cash deposited to the project account. Lenders require all equity to be in before the first construction draw. Land bought years ago and now worth more provides equity at its current value, which is how many small developers fund their share without cash.

Presales, a strong track record, a tier one builder and a conservative end value all push loan to cost up at banks. Mezzanine or preferred equity from a second funder can lift total funding to 85 or 90 per cent of cost at a much higher blended rate. Private lenders offer higher LTC with less paperwork and more expensive money. The question a specialist answers is which mix leaves the most profit after finance costs.