Commercial construction fund builds in stages using progress draws released upon milestones verified by a quantity surveyor. Gearing is assessed against total development cost and gross realisable value rather than a simple loan-to-value ratio. Interest is often capitalised during the build period. Non-bank lenders offer flexibility for projects requiring high leverage or lower presale cover compared to major banks.
For local buyers, construction loans distinct from standard residential mortgages.
Construction Loans Explained
Unlike standard home loans where the full amount is advanced at settlement, commercial funding for development is released in stages. These progress draws align with the build program, with capital provided only when specific milestones are reached. This process is typically verified by a quantity surveyor who inspects the site to confirm that the work has been completed to the required standard before funds are released.
For developers, this structure offers interest efficiency because interest accrues only on the drawn balance rather than the total facility limit. Lenders also hold a retention amount from each draw, releasing it only upon practical completion to ensure all defects are rectified. This method of managing risk is a cornerstone of modern construction, ensuring that capital expenditure matches physical progress.
Dual gearing metrics for feasibility
Feasibility analysis for a development project requires a more nuanced approach to gearing than a simple loan-to-value ratio. Lenders look at two primary metrics: the loan to total development cost and the loan to value against gross realisable value. The LTC measures how much of the hard and soft costs the debt will cover, while the GRV ratio measures the debt against the end value of the completed project.
Using these dual metrics provides a clearer picture of project viability than a single snapshot. It allows developers to understand their equity position throughout the lifecycle and helps lenders ensure that the final debt load is sustainable given the expected exit strategy. A facility that tracks both metrics helps identify potential shortfalls in equity or profit margins early in the planning phase.
When non-bank lenders fit the deal
Major banks often apply conservative policies regarding presale requirements and maximum leverage limits. When a project falls outside these rigid parameters, non-bank lenders can assess the deal on its individual merits. Common scenarios include developments requiring higher leverage to preserve equity, projects with presale cover below bank thresholds, or those with tight build programs that a major bank cannot meet.
Non-bank lenders focus on the holistic view of the exit strategy and the strength of the builder, rather than just checking boxes on a standard credit template. While the cost of capital may be higher, the ability to proceed with a deal that would otherwise be unfunded can justify the expense. For those exploring these alternative pathways, understanding the nuances of commercial construction funding is essential.
Senior debt versus layered capital
A construction loan typically serves as the senior debt facility, funding the build itself. However, many larger or higher-risk projects require a broader capital structure. Development finance can layer in mezzanine debt or preferred equity behind the senior loan to increase total leverage.
This layered stack allows developers to minimise their cash equity contribution, although it increases the overall cost of capital due to the higher risk premium on subordinated tranches. Understanding whether a project needs a simple senior facility or a complex development stack is crucial for selecting the right funding partners and structuring the deal for optimal returns.
- Prepare feasibility. Calculate total development cost, gross realisable value, and profit margins to ensure the project supports the debt.
- Secure builder and program. Engage a qualified builder with a strong track record and establish a detailed build program for the lender.
- Define exit strategy. Confirm how the loan will be repaid, whether through presales, a refinance, or a bulk sale upon completion.
- Submit application. Provide detailed project plans, financials, and builder contracts to the lender for assessment.
| Criteria | Major Banks | Non-Bank Lenders |
|---|---|---|
| Presale Requirements | Strict thresholds required | Flexible, often lower |
| Leverage Caps | Conservative caps | Higher leverage available |
| Timing | Longer standard timelines | Can accommodate fast tracking |
Common questions
How is interest handled during the build? Interest is typically capitalised within the facility during the construction period. This means it is added to the loan balance rather than paid monthly, with the total accrued interest settled at practical completion.
Why are presales important? Presales demonstrate market demand and reduce the lender's risk by securing pre-committed buyers. Non-bank lenders may require fewer presales than major banks, focusing instead on the overall exit strategy.
What is the role of a quantity surveyor? A quantity surveyor verifies that each build stage has been completed according to the plans before a progress draw is released to the builder.
This content applies to commercial property development in Australia and is general in nature.