Understanding Commercial Development Loans 

What is a Commercial Development Loan?  

A commercial development loan, similar to a residential construction loan, is tailored for building projects. However, banks apply stringent requirements, necessitating thorough research on the construction location and certified builders. 

Loan Limits and Conditions 

What is a Borrowing Limit? 

Commercial development loans exhibit similarities to residential construction loans, but banks maintain stricter Loan to Value Ratios (LVRs). General borrowing limits include up to 75% of land and construction costs or Land to Development Cost Ratio (LDCR), or 65% of the on-completion value. Specialized commercial properties, like landfill or waste management facilities, may have lower LDCRs (50-60%). Loan amounts exceeding $20 million are considered on a case-by-case basis. The maximum loan term is up to 3 years, with an interest-only period during construction, and line of credit options. 

Securing the Loan: Collateral and Guarantees 

What Can Be Used as Security?  

Several elements can be utilized to secure a commercial development loan, including a registered mortgage over the property being developed, a General Security Agreement (GSA) covering all rights and undertakings related to the security property, and directors/shareholders’ guarantees. Additionally, rights to designs and intellectual property are considered, requiring input from an architect. 

Property Valuation Process 

Banks’ Valuation Criteria  

Property valuation is a pivotal aspect. Two valuations occur: one for construction cost plus land value (75% LDCR) and another for on-completion value. The lower of the two values determines the loan amount. For example, with a land cost of $2 million and $6 million for development, the initial valuation allows borrowing up to $6 million. However, with a final value of $15 million, applying a 65% LVR permits borrowing up to $9.75 million. Banks usually base the loan on the lower value. A certified valuer, often arranged by the bank, assesses the property based on development plans. Costs for this valuation, typically $5,000-$10,000, are the borrower’s responsibility. 

Valuer’s Criteria  

The valuer considers various factors, such as the number and size of units, location, property type, construction costs, borrower contribution, and construction schedule. A minimum of 70-90% pre-sales is typically required for unit or apartment block development. Moreover, the borrower must possess experience in building commercial properties. 

Revaluation and Ongoing Reviews 

 Commercial developments undergo periodic reviews, usually annually, with property revaluation every 3 to 5 years. These reviews address fluctuating property prices, tenant stability, and potential changes in property value. Banks may adjust the Loan to Value Ratio (LVR) based on lease expirations, using a weighted average lease expiry (WALE) to project property vacancies. 

Factors Influencing Loan Approval 

Lenders’ Return on Investment Calculation  

Lenders conduct internal calculations to determine desired returns based on the amount lent. Existing relationships with the bank, such as home loans or investments, provide negotiating leverage for lower commercial rates and reduced line fees. 

Property Type Considerations  

The type of commercial property to be developed impacts the loan approval process. Whether it’s residential units, a warehouse, a pub, or a hotel, a certified valuer is essential to assess the plans. Loan limits may vary (50-60% of the property value) based on the property’s categorization as standard or specialized. Specialized properties, like service stations and pubs, may receive more favorable consideration with demonstrated community need. 

Insights and Tips for Commercial Developers 

Oversupply Cautions  

Careful selection of the development location is crucial to avoid contributing to local oversupply issues. Awareness of existing and planned large-scale developments in the area is vital. Coordination with local councils helps determine potential development plans. 

Due Diligence for a Smoother Development Process 

 To ensure a smoother development journey, developers should: 

• Check Government Regulations: Stay updated on building standards and regulations relevant to the property type. 
• Verify Zoning Compliance: Ensure the property is in the correct zone by checking with local councils before applying for a commercial development loan. 
• Research Council Plans: Understand upcoming infrastructure developments that can impact property value. 
• Study Location: Analyze comparable commercial property prices in the area. 
• Build a Strong Team: Collaborate with licensed builders, experienced tradesmen, architects, and town planners for a streamlined Development Approval (DA) process. 

Commercial Development Loan FAQs 

Presales Significance for Unit Blocks 

 Presales are crucial for developers to clear debts. Lenders may require 50% presales for debt coverage under $5 million, with potential 100% presales needed for amounts exceeding this. 

Mixed-Use Shop Front Development  

For developments with commercial or retail spaces below and residential units above, a significant number of residential tenants are initially required, while preleased commercial tenants can follow. 

Refurbishment or Shop Fit-Out Loans  

While refurbishment loans are offered by some lenders, securing favorable terms depends on choosing the right lender. Fit-out loans may be available, but selecting a suitable lender is essential. 

Challenges with Studio Apartments  

Units under 40sqm2 can pose approval challenges, as banks often question the market appeal. Developers may need to increase unit sizes for approval. 

Successfully navigating the landscape of commercial development loans requires meticulous planning, understanding property valuation intricacies, and strategic collaboration with certified professionals and industry specialists.