With housing at such critically low levels of supply, people pressure is forcing all levels of Government to consider how to introduce more dwellings for our increasing population.

This means 2023 should see more duplex projects receiving approval, and this will occur Australia-wide.  In a nice piece of market synchronicity, new build construction has dropped from the peak of December 2020 and material supply is opening up, easing construction costs.

If you own a property that qualifies for a duplex development, there’s never been a better year to get moving on your project.

Before you start though, it’s important to gather all the facts.  I sat down with Luke Xie, Senior Finance Broker at SF Capital to get his take on the critical factor of organising finance for your project.

1. What are the ways people can fund their duplex or similar construction projects?

Funding is available in the form of a loan from a bank, non bank or even private lender. If you’re building from scratch, separate loans are used for the land and construction component. However if you’re planning a knock-down rebuild project – for example if you own a house and want to swap it for a duplex – then a construction loan or development loan depending on each bank’s different criteria.

As with all types of lending there is a risk return ratio, meaning the more risk the lender is taking on they will cover this by charging a higher interest rate. Construction loans only cover the period of construction, and then you should ideally switch back to a more normal residential loan facility so if you are charged a higher interest rate for the construction it will only be for a limited timeframe.

In a similar scenario to obtaining a residential loan, if you’re applying through a bank the loan application will be looked at by the bank’s residential loan department, which means you need to demonstrate the ability to service the loan.

A private lender will have different criteria as they provide short term funding, usually over 3 to 12 months with pre paid interest, so they are more concerned about how you will pay back the principal at the end.

Your choice between bank or private lender will depend on your particular situation though private lenders are more often used when there is a lot of profit to absorb the higher costs.

2. How can people decide what they need?

There are five steps I recommend.

a. Know your desired end result

Before you take the plunge into a big project it is essential that you know why you are doing it, and what you are looking to achieve. During this exercise you should also naturally evaluate the opportunity cost of your capital, is building a duplex really the best use of your money or is there another way to achieve a similar outcome?

Based on your target outcome we can also provide helpful finance related insights. For example we sometimes are told by clients they want to build a duplex so they can live alongside family with each side owned separately. We remind these clients that upon completion, to split the loan into two under different names, the respective borrowers must be reassessed and approved.

Another example is if you are building to earn a profit. It’s very important to speak with your accountant about which ownership structure would suit your personal situation.

You may purchase in your personal name or another entity like a company or trust instead. This is a non-negotiable step because it’s very expensive to undo the wrong structure and there are material impacts on your tax obligations and even lending options.

This all being said, with effort comes great rewards so with the right team of professionals around you don’t be scared to lean in!

b. Assess borrowing capacity

The second step is to assess borrowing capacity.

I like to say – it all starts with borrowing capacity because if you tried to save the money all on your own, it would take a very long time, and even if you had enough to do it without borrowing, then yes you could skip this step. BUT, borrowing helps you increase your return on equity, so you can potentially do more projects.

Generally when there are two dwellings or less, the application will be looked at by the bank or non bank’s residential loan department, which means you need to personally demonstrate the ability to service the loan. This is tested over the term of the loan and under harsh conditions, such as adding a 3% buffer to the actual rate and shading rental income by 20-30%.

As mentioned earlier – if your project has significant profit – it might be appropriate to use the services of a range of private lenders.

If you are a business owner there will be a big difference between how much of your income various lenders include. This also applies to employees that earn variable income such as bonus, commission, overtime or allowance.

So definitely invest the time and effort to find a mortgage broker that specialises in your scenario as it can get complicated and the answers change all the time.

c. Determine your deposit

The third step is to determine how much of a deposit you have. Your deposit can be cash savings as well as equity in property but keep in mind equity in property is still borrowed money so that will come out of your borrowing capacity.

A common mistake we see clients building a duplex make, is they believe when assessing the loan for the land and construction, the bank will lend against the as if complete value i.e. the value of the individual duplexes once they are built.

This is not the case because the bank’s valuer will only value it as ‘one line’ or one house, as the subdivision is only completed once construction is completed. The result is a lower valuation. How much lower varies depending on the property and market conditions – 20-30% is the typical reduction we see if you’re working on a ‘new build’ project. So this means when you apply for the land and construction loans, you need to be prepared with your normal 20% deposit plus an extra 16 to 24%.

Of course, if you have significant equity in an established property – like a house on a duplex sized block – then you will have a much more straightforward pathway. Once again, the amount you can borrow will depend on your personal situation and commitments.

Upon completion of the project, you can obtain a new residential loan to cover your next steps – for example retaining both new dwellings. Remember you will still need to meet the lender’s servicing requirements, so ensure you work this out in the initial planning stages. Other options may be to sell one side of the duplex and retain one, or sell both.

d. Set a budget and a contingency plan

After you know how much you can borrow, and how much deposit you can contribute, the fourth step is to set a project budget and contingency funds.

Given there is a construction period where you will not be generating income, it is critical that you set aside contingency funds for:
– construction delays due to bad weather, labour shortages, material/supply issues
– cost variations, especially for out of contract items and for miscellaneous approvals such as the DA or CDC and even the Occupational Certificates.

If you’re building a duplex as your home, then there is the added consideration of extending your short term accommodation arrangement, whether that is renting, living with family or living in another property.

e. Obtain pre-approval

The last step is to obtain pre approval.

By engaging an experienced mortgage broker like SF Capital, we will make sure you only proceed to this step if there is a strong case and confidence you would be approved for what you need.

3. What trends or changes do you see on the horizon for people trying to decide on their next steps?

All things being equal, with rates rising an individual’s borrowing capacity drops. A rule of thumb you can use is every 0.25% rate increase reduces your maximum borrowing capacity by 5%.

Whilst many suburbs across Australia are softening, the price drops are slowing. If you have owned your property for a few years, it’s likely you will still have substantial equity you can access. Take notice of what’s happening in your suburb and if you see duplexes and renovations occurring it’s definitely worthwhile doing the numbers to see if it’s the right time to start your project.

4. Can you give us a few tips?

Yes – of course my biggest tip is to follow the steps above of being clear on your desired outcome before you start, assess borrowing capacity, determine your deposit, set a budget and contingency plan, and obtain pre approval.

My other tip is that as long as you are financially ready, take action early and trust in your team of professionals to manage the distractions, so you are just left with the decisions to make it as successful of a project as it can be.

5. What are the traps to avoid in the current market?

  • Valuation risk on the construction – this can be mitigated by doing an upfront ‘as if complete’ valuation and reconfiguring the plans and specifications as required. Upfront means it is ordered prior to submitting the loan application so you have clarity on what property value the bank will use when assessing the loan application.
  • Valuation risk on existing properties used for equity – using our access to different lenders who have different panel valuers, it’s possible to achieve a different valuation outcome for the same property
  • Running it thin without contingency funds – because there are a number of external forces that can work against you, cash is king to help you ride through it

6. How easy is it for people to achieve their goals?

Not easy by yourself and especially with conditions changing frequently, so be sure to select your support team with care.

7. What are the key costs people need to consider?

  • For duplex construction the loan is usually paid out once it is subdivided and refinanced into two, so the mortgage broker would normally charge a fee for their services.
  • Architect
  • DA costs if the site is located in a council area where CDC is not applicable
  • Interest holding costs for the construction period plus a 3-6 mth for delays
  • At least 10% of the construction + out of contract item costs as a contingency for cost variations
  • Property lawyer fees – please check with your relevant professional
  • Buyer agent fees – please check with your relevant professional

About the interviewee

Luke Xie is a Senior Finance Broker at SF Capital for Residential and Self-Employed Clients. He helps the firm’s clients optimise their property portfolio, capitalise on the next investment opportunity or purchase their forever home. For more information : www.sfcapital.com.au; www.facebook.com/sfcapital/ or www.linkedin.com/in/lxiexie.

About the author

Debra Beck-Mewing is the Editor of the Property Portfolio Magazine and CEO of The Property Frontline.  She has more than 20 years’ experience in buying property Australia-wide and has extensive experience in helping buyers use a range of strategies including renovating, granny flats, sub-division and development. Debra is a skilled property strategist, and a master in identifying tailored opportunities, homes and sourcing properties that have multiple uses.  She is a Qualified Property Investment Advisor, licensed real estate agent and also holds a Bachelor of Commerce and Master of Business. As a passionate advocate for increasing transparency in the property and wealth industries, Debra is a popular speaker on these topics.  She is also an author, podcast host, and participates on numerous committees including the Property Owners’ Association.

Follow us on facebook.com/ThePropertyFrontline for regular updates, or book in for a strategy session to discuss your property questions. 

Disclaimer – This information is of a general nature only and does not constitute professional advice.  We strongly recommend you seek your own professional advice in relation to your particular circumstances.