Part of The FracHaus guide to property development

What if there was a magic formula that could help you compare property development crowdfunding opportunities faster than ever before?

And what if this formula also gave you more peace of mind that you were not ‘picking and praying’ and that your chosen property development crowdfunding investment would do well based on the return alone? If only right?

Any form of property investing can be confusing at present. Depending on which media headlines you read… it’s either good news, bad news or something in-between.

Many of our investors are turning their attention to investing in property development crowdfunding opportunities to boost their wealth independently of organic property market returns.

Why property development crowdfunding presents its own challenges

Property development crowdfunding is where investors pool their finances to get developments off the ground. It is a regulated form of investing, so ASIC’s MoneySmart guide to crowd-sourced funding is a sensible first stop before you compare offers. As property market data specialists we rely on algorithmic research to guide our decisions and that includes which property development projects we back.

I want to introduce two basic investing concepts that might make your life a lot easier when deciding between competing property development crowdfunding opportunities in the market namely:

CAPITAL STACK >> where in the financial structure of a project your capital would be used, and

DEVELOPMENT RISK STAGE >> where in the development process your funds would be deployed.

Each have their own levels of risk and expected returns. When you examine both you can quickly decide if the returns offered are in line with general market expectations… or better.

Why is this important?

In the past we have sponsored an off-market opportunity offering a 42% return.

Instantly, prospective investors assumed it to be a “very high risk” project given that the returns offered were comparatively high.

As it happens the risks were quite normal given where in the capital stack and development process my investors were participating. The returns though were indeed comparatively very high. But the risk was not.

So next time you see an advert offering property development returns of 10%… 15%… 30%, make sure you understand where in the risk spectrum the offer sits.

So let’s see how you can do this….

The Capital Stack

A three-tier stack of senior debt, preferred equity and equity with a townhouse on top, illustrating the property development capital stack

The capital stack is made up of debt and equity.

My investors were offered an EQUITY investment which means they would have expected returns between 10-20% due to a pure equity investment being on the higher end of the risk spectrum. (The actual return was 42%.)

Equity: 10-20%

Equity owners share in the profits of the project with their returns being uncapped.

They are in the riskiest position being the last to be paid and therefore expect the highest returns to compensate for the risk.

Equity investors also own the asset which means they only get paid when the asset is sold or they sell their interest in the asset.

Preferred Equity: 6-12%

These investors generally get paid a fixed return before the remaining profits are paid to the developer and other lower ranked investors in the capital stack.

Well-structured co-development offers sit in this layer of the stack: the investors’ return is paid before the developer takes any profit.

Senior Debt: 4-10%

The senior debt (usually “bank debt”) is typically provided by a lender with a 1st mortgage on the property. They take the least risk but also get paid the least in the form of interest.

Some property developers prefer “no bank debt” in their capital stack. This avoids the deep scrutiny and due diligence typically undertaken by the banks. We prefer projects with some senior debt in the capital stack so that there is an additional layer of independent project scrutiny and oversight.

Development Risk Stage

Now that you know where in the capital stack you’re investing, next you need to know where in the development process your money will be used.

You’ll notice the earlier in the development process you invest, the more risk you encounter, and the more you should be paid for this risk. These risks can be broken down into the following general categories:

Site Acquisition. Was the site purchased for the right price under the right terms? If this is wrong then the project may not be feasible or profitable from the outset.

Council Approvals. What if the DA is approved but without the necessary yield the profit assumptions were based on?

Pre Sales. Banks will often only lend when there are enough pre-sales to prove demand for the end product from the market.

Bank Funding. Is the bank prepared to back the project and developer on reasonable terms? If the developer cannot get funding then they may have to seek alternative (and costly) options that can reduce the overall profit shared with the equity investors and the developer.

Construction. Has a builder with a strong reputation for building on time and budget been appointed on a fixed price contract? Weather delays, industrial action, delay from contractors can make or break a project’s profitability and the investors’ returns.

Settlement. Are the end buyers of the finished properties able to settle on time at the contracted price so that profit expectations are achieved?

The appropriate ASIC prescribed project offer documents should disclose all the relevant risks including those above associated with the development process.

My investors made an equity investment at the very beginning of this project after the DA was obtained and they were tied to the project results on an equal basis with the developer (joint venture).

In contrast…

Clients of mine were offered a 15% fixed return in a project that is already quite far in the development process PLUS…

It’s a preferred equity investment… so investors’ profits are paid first before the developer and the other investors are paid.

Construction is about to start… with DA… BA… bank funding… pre-sales, etc in place.

Comparative returns elsewhere would average around 8-10% for similar levels of risk based on the capital stack.

So you can see it really depends on which stage you are investing in and what form of capital you are providing, i.e. debt or equity.

If the co-development path might suit your risk appetite and objectives, the same two concepts apply, with one difference at the end: at completion you choose between a cash return or retaining a completed home at developer cost price. You can pressure-test the cost-price maths with your own numbers in our Manufactured Equity Calculator, or join the community and tell us which pathway fits.

General information only. Nothing here is financial, credit or tax advice, and past project results are not a promise of future performance. Speak with your licensed adviser before investing.

Frequently asked questions

How does property development crowdfunding work in Australia?

A platform or sponsor raises money from many investors to help fund a developer's project. You typically hold units in a unit trust or a loan note, not the property itself. Your return is paid out of the project's proceeds when it completes and sells, so it depends on the project being delivered on time, on budget, and into a market willing to pay the forecast prices. Many current offers are open to wholesale investors only, with minimums around $20,000.

Is property development crowdfunding safe?

No property investment is risk free, and crowdfunded development sits at the higher-risk end because your return depends on a project being delivered on time and on budget. The risk varies enormously with your position in the capital stack and the stage the project has reached. Senior debt secured by a first mortgage on a fully approved, pre-sold project is a very different proposition to unsecured equity in a site that does not yet have development approval.

What returns are typical for property development crowdfunding in Australia?

As a rough guide, senior debt positions typically target 4 to 10 per cent per annum, preferred equity 6 to 12 per cent, and ordinary equity 10 to 20 per cent or more. A higher number is not automatically a better deal. It is usually just a lower position in the queue to be paid, or an earlier entry into the project's risk curve.

What is the difference between debt and equity crowdfunding for property?

Debt investors lend money and receive interest, with first claim on the project's proceeds. Equity investors share in the profits, are paid last, and can lose their capital if the project underperforms. Preferred equity sits between the two, with a fixed target return paid before the developer takes profit.

How is co-development different from property crowdfunding?

In crowdfunding you fund someone else's project through a platform and hold a loan note or units in a trust, with a cash return as the only exit. In a co-development you invest in the project alongside the developer, your return ranks ahead of the developer's profit, and at completion you choose your exit: take your return in cash, or put your capital and profit toward retaining one of the completed homes at developer cost price, with your name on the title.

Are crowdfunded property returns guaranteed?

No. Target returns are exactly that, targets. Construction delays, cost overruns, failed settlements or a soft sales market can all reduce or wipe out returns, and equity investors carry those outcomes first. Any platform or promoter suggesting a return is guaranteed is a red flag.