As loan demand surges, how can developers secure enough funding?

The dream of a 1000-square-metre section is slipping further from Aucklanders’ reach, with standalone houses accounting for a declining share of new building consents each year. Meanwhile, medium- and high-density housing is surging, subdividable land is becoming increasingly valuable, and enthusiasm for development is sweeping Auckland. Add a severe imbalance between housing supply and demand, unprecedentedly low lending rates and, particularly, expectations of further rate cuts sparked by the government’s recently introduced Funding for Lending Programme (FLP). These overlapping factors are pushing the property market to successive highs, with the land development market becoming especially frenzied and demand for loan finance rising sharply.

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However, land subdivision is a highly involved process. Every field and stage carries varying degrees of risk, all of which can affect development costs, timelines and returns. The first—and most important—step is to secure sufficient funding.

Confused about the different loans available for development and construction?

Hoping to apply once and receive all the funding in one go, as with a home loan? That is not possible! Different stages of land development require different types of loans, each with its own eligibility requirements.

Generally, development and construction loans are classified by the security offered. Lenders accept land and buildings as security.

Buildings are self-explanatory, while land falls into two categories. The first is serviced land: building-ready land with water, electricity and gas connections in place, on which construction can begin directly. The second is unserviced land, generally a large site that requires resource consent (Resource. Consent) from the authorities before it can be subdivided, with construction possible only once water, electricity and gas connections are in place.

Accordingly, three types of loans cater to different stages of development and construction:

land loans, subdivision loans and construction loans.

1. Land loans

A land loan generally uses the land itself as security, with the funds used to develop it for subsequent house construction. Here, we are referring to loans for unserviced land. There is much to consider when buying an unserviced site, and undertaking a feasibility analysis beforehand can save time and money and prevent considerable trouble.

Features of land loans:

• Relatively short terms: These loans generally do not run for long, with the term usually depending on the construction timeframe.

• Relatively low lending ratios: Banks generally lend no more than 50%, usually depending on the land’s location.

Eligibility requirements:

1. The land is in an urban area where values hold steady or rise rapidly—in other words, a good location;

2. The applicant has a sufficient deposit or can release equity from an existing property to fund it;

3. The applicant has a stable long-term income and the ability to repay the loan, or a clear investment and financing plan, as is usually the case for experienced developers.

 

2. Subdivision loans

Subdivision loans generally fall into two categories. One funds the division of a serviced site with an existing home into two or more lots. Such developments are generally small and require relatively little funding, so many developers use their own money at this stage rather than borrowing. For clients who plan to build after subdivision or have limited liquid funds, our advice is to consult a professional who can assess whether a loan is needed and how to arrange it, based on the land, available funds and development plans.

The other category primarily funds the subdivision and development of unserviced land—for example, dividing a large site into dozens or even hundreds of lots and installing water, electricity and wastewater infrastructure. Both subdivision and development involve resource consent applications and require collaboration among numerous professionals.

It is important to note that financing for the latter category must be applied for and arranged separately according to the project’s circumstances. Some large projects take 5 to 10 years, with different financing needs at each stage. Some combine land and construction loan applications, using both the land and buildings as security. Others are exceptionally large developments involving the subdivision of a site into dozens or hundreds of lots. These loans are relatively complex and, as this article focuses on development projects for general readers, they will not be discussed in detail here.

 

3. Construction loans

Generally, a construction loan is short-term finance for building an investment property or a home to live in, or for developers undertaking property projects. Funding comes from either banks or finance companies, each with its advantages. Banks have clearly defined requirements for small and medium-sized construction projects but offer lower interest rates. Finance companies charge higher rates but have less demanding requirements, faster approvals and simpler drawdown arrangements. In New Zealand, construction is divided into houses or units and apartments. Loans for small developments—such as building a home to approved plans on a site of about 300 square metres, or 4 homes on a 900-square-metre site—are relatively straightforward and quick to arrange. Medium and large developments, such as multiple standalone homes, townhouses or apartment buildings, require more capital and longer construction periods, making lending more complex. Lending ratios and interest rates generally need to be assessed against total project costs and pre-sales.

Construction loan terms are generally 1 year, 18 months or 2 years. When the loan matures, a successfully completed project can be sold to repay it. If some homes remain unsold, borrowers can apply for an extension or change the loan type—for example, retaining the homes as rentals, offering them to the bank as security and applying to convert the construction loan into a home loan to reduce interest costs. Note, however, that extensions generally incur additional fees.

Basic information required for an application:

1. Evidence of the applicant’s stable long-term income

2. Details of liabilities

3. Details of expenses

4. Resource consent

5. Building consent

6. Valuation report

7. Construction contract (Fixed Price Contract)

8. Building company credentials: An experienced building company is generally required.

Requirements vary between banks and financial institutions. Documentation should be prepared according to the applicant’s and project’s circumstances to meet the lending criteria.

Tips

Progressive drawdown: Construction loans are paid out very differently from home loans. A home loan is released in a single payment after settlement, while a construction loan is released progressively according to the building plan. Invoices and photographs showing progress on site must be provided at each stage. A quantity surveyor (QS) may also be required.

Before the bank releases the final portion of the loan, the following must be completed:

• Code compliance certificate (CCC)

• Confirmation report from a property valuer

• Conversion of construction insurance to home insurance

 

Is securing a loan harder than reaching the heavens?

Having read about these loans, do you feel your circumstances make approval impossible? Do not worry—you are not alone.

Securing sufficient funding is already one of the most difficult aspects of land development and one that demands considerable experience. When we think of borrowing, banks usually come to mind first because their lending costs are low. However, fully meeting a bank’s project pre-sale and profit margin requirements to secure approval is far from easy.

In fact, banks’ basic requirements for development loans have barely changed over the years. These non-negotiable conditions cause considerable headaches for many small and medium-sized developers, adding substantial difficulty and expense to smaller projects.

For example, in many years of practice, Chinese builders and developers have rarely commissioned QS reports, yet these are an essential bank lending requirement. Strict bank requirements have made finance companies popular. There are currently thirty to forty finance companies active in New Zealand. Although their interest rates are higher than banks’, they help developers avoid many difficulties and offer relatively flexible financing arrangements. The resulting savings can offset the interest rate difference.

Tips

Mandatory bank lending requirements

1. Construction contract: This is the main construction contract signed between the owner or developer and the building company. Banks impose numerous requirements on its contents, including the timeframe, price and terms.

2. Developer and building company experience: Their previous involvement in relevant projects must be reviewed.

3. Upfront investment: Banks require developers to invest their own funds first, releasing bank funding later once they have established that the homes have value.

4. Pre-sale requirements: Pre-sales of more than 50% are usually required. Generally, a single buyer cannot purchase more than 2 homes and must pay a deposit of at least 10%.

5. QS reporting: The bank appoints a firm to monitor project progress and risks.

 

How can you secure a larger loan?

Whether you are buying your first home, investment property number 3, or land on which to build, the underlying principle for increasing your borrowing limit is the same: a key factor in the bank’s assessment is the ratio of your income to expenses. Banks use their own formulas to determine each customer’s borrowing capacity based on affordable repayments in New Zealand.

Main income sources generally include:

• Salaries and wages: Employees are the group that finds it easiest to obtain loans;

• Business or shareholder income, if you are self-employed or own a company;

• Overseas salary income from working abroad, which requires more extensive income evidence.

Alongside your main job, part-time earnings, bonuses and allowances, rental income, family benefits and child support may be recognised in full or in part, adding to your total income and increasing your borrowing capacity. However, most lenders consider only sustained, long-term additional income. Occasional or one-off income

will not be accepted. All income must also be supported by evidence, such as tax statements for the past two years or several consecutive months of bank statements. In addition, because of the pandemic, many income sources previously accepted are no longer recognised this year, so each case needs individual assessment.

For construction loans, the total project cost and its ‘as if completed’ value also affect the amount available, alongside the income sources above. Banks primarily set the loan-to-value ratio (LVR) according to the anticipated completed value: required borrowing / (land value + construction cost) = LVR.

So what makes the best construction loan? There is no single answer. However, we can assess construction loans as products against these criteria: a high borrowing limit, fast approval, sensible drawdown arrangements and low fees and interest. It is difficult to score an A on all four. With so many financial institutions and differing requirements, it can help to find a mortgage adviser you trust. Their professional knowledge and industry experience can help borrowers secure the best financing solution for the developer’s circumstances and needs.

About the author:

York Zhang

In 2006, York. Zhang (Zhang Yong) founded Huarong Finance, providing the Chinese community with loans for homes, construction, businesses, land development, vehicles and large equipment.

Combining his professional mortgage broking knowledge with his personal experience of living in New Zealand, York. Zhang hopes to use Huarong Finance to introduce more products suited to the Chinese community’s circumstances and needs, develop more outstanding mortgage advisers, and unlock more capital from Chinese clients’ assets for reinvestment.