A combination of the buoyant property market, low interest rates and relative demand has fuelled the rise in short-term construction loans. The metropolitan property markets continue to surge. The malaise has gone, and confidence is up. In addition, interest rates have consistently demonstrated little movement and remain at unprecedented lows. The upshot: money is cheap.
This provides the perfect landscape for property developers. Typically, a developer would secure their construction loan and works would commence. However, it’s also commonplace that by the time the build is 70 to 80 per cent complete, the developer finds themselves in a very common situation.
Few construction projects come in on budget. Ambitious building schedules and construction variations often result in cash-flow shortages at the back-end. Constrained by the first mortgagee’s cost to complete schedule and likely limits on the LVR, funds need to be sourced to keep the project progressing. They need money – and quickly – to complete.
Most developers seek maximum funding limits. It is the nature of the beast. Reassessing a construction loan is a timely process and is unlikely to keep pace with the project's timing requirements. Going back to the bank to seek an increase for unaccounted costs can also suggest that the developer’s project management and financial strength has gaps.
With works outstanding, tradespeople and suppliers to pay and a bank unwilling to advance final drawdown amounts, the progress on the project comes to a halt. Unfinished projects have a disproportional value compared to the amounts required to complete. Stymied by bureaucracy and size, big banks are slow and inflexible. They are also enjoying a surge in demand for investor property purchases, which equates to relatively simple lending that can be fulfilled with standardised products. Their focus isn’t on short-term construction finance, which by comparison, requires customised solutions delivered quickly.
A short-term loan is required to bring the project to completion. This typically equates to a $100,000 to $600,000 loan over one to three months. Funds are usually provided by way of a series of drawdowns, which are essentially a quantifiable ‘pay per use’ facility for the borrower (the lender requires proof that the drawdown funds are being used for the specific purpose identified prior to releasing further funds). This proves the most cost-efficient and flexible structure for the borrower, and offers the least risk to lenders (which in turn can affect the interest rate, which is influenced by risk).
The opportunity for brokers
The market for construction finance loans continues to rapidly grow. Diversifying into short-term lending enables access to this market potential and represents the immediate opportunity for brokers to boost their bottom line, expand their client base and strengthen their service offering.