Cash flow the biggest killer of property developers
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We often see small to medium sized property developers struggle for cash flow and, in our experience, it is the single biggest reason for developers going under and as they say, “cash is king”!
The very nature of property development is that a project will only incur costs throughout its lifecycle until the construction is complete, titles are available and the properties are sold and settled. In most cases, this process takes some 12 to 18 months and that is a long time to be expending money, even if it is borrowed and not receive any income.
By definition property development is a capital-intensive and cash flow poor industry and developers who don’t have an ancillary business that provides them with an alternative source of income need to work smarter at what they do.
Some property development cash flow strategies to consider
1. Be smart and replace some of your equity during the project lifecycle
How and when you utilise your capital can greatly reduce the demand on your cash flow and it is important to remember that in most instances, project risk reduces as the project progresses. It therefor follows that the earlier in the project timeline that you borrow money, the more expensive that money will be.
Obviously, the most capital-efficient way would be to use other people’s money (OPM) as much as possible, however that comes at a cost and delaying the point in time when you ustilise OPM will reduce this cost.
As an example, in the current market environment the cost of funds for any ‘non-mortgage secured’ money i.e. risk equity, will reduce over time as shown below:
2. Schedule projects efficiently
If you only have enough equity to develop one project at a time the ability to maintain a consistent flow of projects and resultant profits is significantly reduced. By taking advantage of the above principals you may be able to make an “equity redraw” and introduce OPM to replace some of your existing equity once you have secured the development approval and some pre-sales. This will then allow you to utilise the capital released to secure your next project without having to wait until the current project is completed.
This approach leverages your equity to make it work more efficiently as well as bringing forward the income streams for future projects and there for improving your cashflow by shortening the timing between project completions and the resultant profits.
3. Keep your overheads low
A very effective strategy many small to medium size Developers use is to engage a multitude of project-specific consultants. By doing this, those consultants are a direct cost to a specific project and the developer avoids carrying ongoing salaries as part of his overheads. In some instances there is also the potential to delay some of the payment for the costs involved to coincide with project milestones further improving the project cashflow.
4. Include a Development Management Fee
By including a development management fee into your project feasibility, you allow yourself to receive income during the project lifecycle. In many instances, the first mortgage construction finance provider will allow a periodic development management fee to be advanced from the loan as part of the professional fees but remember that it needs to be kept reasonable, reflecting your contribution to the project.
5. Negotiate your settlement terms
During the early stages of a typical development project lifecycle, the most capital-intensive part will be the settlement of the development site. By negotiating favourable settlement terms, you can potentially delay paying for the property until you have substantially removed the Approval risks associated with it. This in turn will improve the funding costs and the project cash flow in general.
6. Have a safety net
If possible, have another business that you can operate in parallel with the development operations. This applies more to smaller businesses that are largely undertaking one project as a time and do not have the capital to smooth out the resultant cash flow lumpiness. Having a small income generating business that requires minimal capital and operating overheads such as a real estate rent roll, small equipment hire business or similar means that when the market is in a serious downturn and you need to be able to just “sit on the beach” and wait it out, this alternative income can be a real godsend.
All of this is important but the real challenge is to actually put it into practice. Sitting down with your accountant and lawyer is a good start but they tend to be reactionary and can only provide some of the answers.
A critical piece of the process is having a clear understanding of the finance and capital structures that are actually available to you and then building your strategy around the reality of those solutions rather than developing a concept and then having to compromise it to meet the market realities. This is where a professional construction finance broker can really add value to your business so the real question is, will you do something about it today or wait until it becomes a regret?
This article was written by Dan Holden of HoldenCAPITAL, who are a bespoke construction finance firm, they arrange construction finance and invest in projects through their equity fund, Queen Street INVEST. To discuss your project finance requirement please call (07) 3171 4200 or visit HoldenCAPITAL here.
