The real cost of finance

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It never ceases to amaze me how some borrowers are fixated on interest rate, but are blind to the overall cost of finance.

When looking at the cost of development finance, you should not only include the application fee, interest rate and line fees. You need to include the other costs hiding behind a cheaper interest rate. Particularly, the cost of achieving pre-construction sales.

The higher marketing costs, interest on upfront fees and holding costs while achieving the sales, along with the cost of additional equity, should also be factored into the cost of finance. They add up.

Lenders like GPS charge at a higher interest rate than the banks, but we will generally lend with reduced or no pre-construction sale requirements and a higher LVR.

Traditionally, I have priced the GPS product on the three month rule. This is if we take three months off the life of the project by reducing pre-sales, providing better service, etc. then we are competitive on an all-inclusive cost basis. Read my article here on The Three Month Rule.

In the current market the banks, if lending at all, require 100% plus debt coverage from pre-construction sales. They need this as a risk mitigant, so as to reduce their beloved cost of capital. On the other side, the sales market has turned, which has made pre-construction sales either very expensive or, more commonly, impossible to achieve. I note that pre-construction sales can also prejudice the Gross Realisable Values as valuers discount marketing fees. Such sales can also be “buying” settlement risk.

Lenders like GPS have a cap on how much lending we will do each year. It amounts to a drop in the ocean compared with bank lending (i.e. when they have an appetite for residential construction lending).

In the current market we are awash with loan applications. When a borrower does not understand the above, and wants to debate our pricing, they slip down the priority list and end up trying their luck with the banks. Often the application is re-presented to GPS after the banks do not deliver.

Residential development is a numbers game. It is about the actual amount of end profit and the risks associated with achieving that figure.

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