As brokers diversify into brave new territories, development finance is moving into their crosshairs – but they must tread with caution.
Could development finance be the next great growth opportunity for brokers?
In a world where broker market share of the residential lending space is nearing its terminal limit, brokers have become adept at transferring their skill sets into brave new territories.
This has led to rapid growth in broker market share of the commercial lending market; within that broad umbrella lies development finance, encompassing land acquisition and construction of residential, mixed-use and commercial projects.
Development finance is still a niche, technically demanding space, full of complexities and trip hazards for the ill-prepared. It requires firm knowledge of project feasibility, exit strategy and presale requirements. Yet that hasn’t stopped a growing cohort of brokers from eyeing the sector with zeal, drawn by larger deal sizes and deeper client relationships.
To get the lowdown on where the space is going – and how brokers fit into the equation – MPA caught up with a panel of leading development finance specialists for this edition’s inaugural development finance pulse check.
“With Australia’s housing requirements over the next five years, brokers have the opportunity to play a much larger role in facilitating funding for developers” – George Lyall, Millbrook
A broad church
Amid shifting risk appetites, both traditional and non-bank lenders play an important role in the development finance sector. Banks are highly active in this space where it fits their credit parameters, but they can be hobbled by issues like presale requirements and leverage limits.
“That’s where non-bank and private credit lenders have been playing an increasingly important role,” says James Munn (pictured, far left), commercial and development finance expert and director of Sydney-based brokerage Chifley Securities. “They can often offer more flexibility around structure or parameters, and in situations where timing is critical they can move more quickly.”
One such non-bank lender is La Trobe Financial, whose chief lending officer, Cory Bannister (pictured, centre right), says it can assess credit “holistically, rather than purely through rigid covenants and policy settings”. This allows La Trobe Financial to support viable projects that fall outside the metrics required by some major lenders, which is “of critical importance in addressing the housing supply gap in this country, now and in the future”.
Risk appetite varies from project to project and from asset class to asset class, while private lenders often stick to a particular niche. So the challenge isn’t necessarily accessing capital but “understanding which lender is best suited to a particular deal”, says Munn.
Millbrook Group general manager George Lyall (pictured, far right) has seen the market become more “tiered”, with banks funding lower-risk projects and alternative lenders supporting projects that require more flexibility. “The major banks remain active but are generally more selective and focused on experienced sponsors, strong presales and lower-leverage structures,” says Lyall.
Pallas Capital group executive Jason Arnold (pictured, centre right) has seen a clear increase in both loan volumes and loan sizes in the private credit space. “A major driver has been the continued retreat of banks from higher-risk segments – particularly construction finance, higher-leverage transactions and projects with lower levels of pre-commitments such as presales or pre-leases,” he says.
Arnold also explains how the growing participation of institutional capital in Australian private credit has materially expanded the sector’s capacity, supporting growth in both settled loan volumes and the size of individual facilities.
“We’re also seeing many borrowers gravitate towards a single, flexible lender who can provide the entire capital stack, whether that’s first mortgage, second mortgage or preferred equity,” adds Arnold. “The ability to offer higher leverage and faster execution is contributing to both higher deal volumes and larger loan sizes across the space.”
Between a rock and a hard place
Development finance is a unique challenge for banks. On the one hand, they have a regulatory obligation to tightly manage risk. On the other hand, they have the unregulated private credit space breathing down their necks. Could this lead to a rethink on risk appetite among the major Australian banks?
In the UK and US markets, where private credit is substantially more mainstream, Munn has seen the banks gradually reassess their lending appetite and approach to remain competitive.
Munn has already seen some Australian banks start to ease up on presale requirements, which have historically been a major bottleneck for getting projects up and running. This does vary depending on the project type, with broadly appealing projects like high-density, affordable residential apartment complexes more likely to attract more easy-going presale requirements than, say, a luxury complex in Darling Point.
It is, however, early days. Lyall explains that banks are still generally looking for 50% presales by debt coverage, while alternative lenders may be willing to work with lower thresholds in exchange for stronger equity or pricing. Millbrook doesn’t have a presale requirement at all.
Traditional banks are also becoming more open to providing residual stock facilities, previously a domain largely controlled by private credit. Chifley Securities recently handled a project that saw a property developer refinance away from a private construction funder to provide the developer with sufficient time to partially sell down and lease up the project’s residual stock.
But Bannister doesn’t see the major banks meaningfully re-entering the development finance space any time soon. “Pullback from development finance by major lenders began some time ago and has been a consistent feature of this cycle, rather than a recent shift,” he says.
Although recent headlines have suggested banks may be pivoting back into the space, prevailing geopolitical uncertainty and broader macro volatility are likely to keep them cautious for longer.
As market conditions remain somewhat uncertain, developers are increasingly turning to brokers for access, structuring expertise and lender navigation” – Cory Bannister, La Trobe Financial
Higher interest rates and elevated labour and construction costs “are undermining project feasibility and increasing perceived lender risk”, notes Arnold. In response, lenders are taking steps to derisk transactions, whether by reducing LVRs or implementing higher-contingency and interest-reserve allowances.
As a result, “credit appetite remains constrained”, says Bannister. He calls it a “bifurcation” of the market. While presale requirements remain tight at the majors, non-banks like La Trobe Financial “are taking a more pragmatic approach, assessing the entirety of the project, including sponsor strength, asset quality and exit strategy, rather than relying solely on pre-funding commitments”.
Lyall is seeing lenders require larger contingencies and more rigorous quantity surveyor oversight “to ensure projects remain viable if costs shift during construction”.
On the bright side, construction costs appear to be stabilising (although the ripple effects of the Iran war are yet to be fully quantified), “but the legacy of volatility means lenders remain cautious”, says Lyall. He adds, “Developers who have locked-in contracts with reputable builders and conservative feasibility assumptions are still able to access funding, but the margin for error is much smaller than it was a few years ago.”
Nonetheless, overall development finance activity remains strong across all lender categories, and appropriate funding terms can be found across all asset types – as long as the broker knows where to look.
Industrial remains a highly financeable asset class due to robust tenant demand, while institutionally backed build-to-rent and affordable social housing projects are going well. Data centres are also emerging as a specialist asset class.
Residential projects, such as townhouses, apartments and land subdivisions, “remain the most attractive from a financing perspective”, says Arnold. “This is largely driven by Australia’s significant housing undersupply, strong population growth and sustained demand.”
Lenders are also showing greater flexibility around presale requirements for projects in metro or high-demand locations. According to Arnold, this is most evident in stronger segments such as residential build-to-sell and industrial.
“That flexibility is still highly dependent on gearing levels and the lender’s confidence in the developer’s ability to meet key milestones throughout the loan term,” he adds.
“The determining factor is rarely the asset class itself, but rather how the project aligns with a lender’s specific credit parameters,” explains Munn.
“Lenders ultimately assess a range of factors, including feasibility, market demand, sponsor capability, construction risk, exit strategy and other factors. However, each lender weighs those factors differently and has its own internal requirements around leverage, presales and project structure.”
Key features of development loans
- Usually short-term, ranging from 6 to 36 months
- Capitalised interest during construction
- Generally up to 70–80% LVR of total development costs or gross realisable value (GRV)
- Staged drawdown funding based on construction milestones
- Repaid upon project completion through the sale of units or refinancing
A warning to the curious
While diversification is all the rage in the broking space, development finance is not somewhere to tread lightly. The skill set required is vastly different from the residential property space, involving knotty issues like feasibility assessments, construction risk, capital structuring and arcane lender credit parameters.
“Development finance is inherently complex and significantly more involved than traditional lending,” says Munn. “In our experience, a number of issues can arise if these complexities are not managed carefully.”
Munn has seen situations where builders needed to be replaced mid-project, construction contracts including variations were not reflected in the original feasibility, and developers faced delays due to labour or trade shortages. He says, “Projects can also stall when lender requirements are not fully understood or key information is provided late in the process. In other cases, previously undisclosed liabilities emerge during due diligence, or valuation and quantity surveyor reports come back materially different from early feasibility assumptions.”
Although the sector presents a great opportunity for broker diversification, “I strongly encourage brokers to invest in the right training and education before stepping into development finance,” says Arnold.
“I strongly encourage brokers to invest in the right training and education before stepping into development finance” – Jason Arnold, Pallas Capital
To those new to the sector, he suggests partnering with an experienced broker for the first few transactions or working closely with a specialist construction lender who can guide them through the process. “The right lender will collaborate with both the broker and the client to ensure a smoother process and help build confidence as you take on more complex deals.”
Bannister often sees brokers engaging their business development manager too late in the deal process. “Development finance rewards early structuring,” he says. “Not all lenders assess risk the same way, and selecting the wrong partner can materially impact execution. It’s for this reason that all La Trobe Financial BDMs are trained in development finance, meaning brokers spend less time chasing answers and more time structuring a submission.”
Lyall agrees that the complexity of development finance is not always understood, although he believes it can be a valuable diversification strategy for brokers who want to expand beyond traditional residential lending.
However, Lyall stresses the importance of approaching the sector with the right level of education and support. He advises partnering with experienced development finance specialists or capital advisers who can help brokers understand deal structuring and lender expectations.
“For brokers starting out, the best way to find opportunities is by building relationships with property developers, builders, planners and commercial agents within their network,” says Lyall.