Ep 261 – The End-of-Project Funding Trap: What Happens When You Need More Money?

Introduction

Welcome to the Property Mastermind Podcast, episode 261. Today Bob and Hilary tackle the end of project funding trap: what happens when you need more money. Very often you do need a small top up at the end, so they break down the reasons it happens and how you structure it.

Bob’s tip: start early

Hilary: Bob, what is your tip for the week?

Bob: When it comes to buying presents for someone special, start early. You have a whole year to think about it.

Hilary: And it applies everywhere, doesn’t it. Property development is the classic one. How long have you been thinking about it, and how long have you been putting it off? We tell ourselves there is an infinite amount of time and money, and there simply is not.

What a top up actually is

Hilary: A lot of people think once the development loan is approved, the finance side is done. But real projects, especially toward the end, can shift. The build takes longer, interest costs a bit more, variations creep in, or sales do not settle as quickly as planned. So when you say a loan top up, Bob, what are we talking about?

Bob: It is more common than people think. A top up can happen at a couple of points. It is not the finance up front to buy the site. When you get to construction, that second stage of finance kicks in and you tip in the rest of your equity. Some people need a small top up there. You can also run out of loan funds toward the end of a project, because it took longer, it consumed your interest cap, or there were overruns beyond your five percent contingency.

Top ups at the construction stage, and why investors like them

Bob: A top up at construction often comes from an external investor, a loan partner, lending at an interest rate with some security. From an investor’s point of view it is an attractive position. The site has been bought and valued, the development and building permits are in place, the builder and building contract are locked in, and a quantity surveyor has reviewed it. From there they are really only relying on the builder finishing and the stock selling. That is very different from investing right at the start, before anything is approved.

A real example: our North Harbour project

Hilary: We have one right now. North Harbour is 16 industrial units in a growing early pocket of the Sunshine Coast. Two weeks from finishing construction we are about 120,000 dollars short, so we are topping up.

Bob: On a build of roughly six to seven million, 120,000 is actually very little. The reasons were a conservative valuation, and an electrical transformer that cost more than we had allocated, around 80,000 extra. The transformer is really an investment, because it lets us sell at a higher price, but we need the cash now and get it back in the sales. The top up is coming from an investor already in the project, as a first mortgage, and we expect it to run six or seven months.

Industrial property and self managed super

Hilary: The new self managed super rules around residential do not apply to industrial. North Harbour is industrial.

Bob: Those super restrictions only apply to residential property. Industrial is a great place for self managed super: a strong yield, and the tenants pay the outgoings, unlike residential. We expect a number of buyers on this project to use their super.

How top ups are structured

Hilary: What does the lender want to see before agreeing to a top up?

Bob: The security could be an unregistered second mortgage with a caveat, or a registered second mortgage. Mortgage law is state by state. Generally you tell your existing financier, and a non bank financier will usually just ask for a deed of priority, which sets out the rights of the first mortgage against the second. In our case the first mortgage is ours, so it is simple.

The biggest mistake, and how to avoid it

Hilary: What mistakes do people make?

Bob: Leaving it too late and putting their head in the sand. You cannot click your fingers and produce a top up. Finding an investor takes time.

Hilary: My approach is to go first to the people already investing in our projects. There is always someone looking for a good return. And the simplest protection is to keep some money in your back pocket.

When sales are slow: the residual stock loan

Bob: If sales are slow and you are running out of loan term, a residual stock loan pays out your development financier and gives you breathing space to sell your stock down one at a time. It avoids expensive loan extensions or penalty interest, and it takes the heat off, so you are not forced to accept the first low offer, which would set a benchmark for the rest.

Hilary: Top up loans happen all the time, just like joint ventures. Development is a fluid vehicle, and the best protection is to get well educated.