Why doesn't the developer borrow from the bank at a lower interest rate instead?

A common question...

That's why I decided to answer this question in the form of a blog. And with a few explanations and examples of how the development business works.

So why doesn't the developer borrow from the bank at 5 % interest, but borrow from crowdfunding at between 10 % to 16 % interest?

The bank can refinance the investment plan, that has a strong potential for a successful sale, is in a good location, has clear and very precise mathematics and resolved legal relations in the territory where the real estate project will be implemented.

But the bank will require one more thing from you. And these are own resources. And it amounts to at least 30 %. In the form of cash, land, construction - anything related to the investment plan in question. The bank will not go into the project with a 100 % loan. 

The ideal case for the bank is as follows

The developer buys the land. He equips himself all the necessary permits for the construction of apartments. He builds a rough construction, which can be registered as a property under construction. And then he the bank will finance it with the part that the developer will need for the approval of the building.

But before the bank sends the money to the developer's account it tells him: ️ "Bring us signed booking contracts for at least 20 % of all the flats you will be selling. Let us be sure it will sell quickly."

Although the bank will lend to the developer at a low interest rate (approx. 5 % p.a.), but the rules of the game are strict and often a good investment plan doesn't even get to the stage where it can ask the bank for money.

What happens if a developer borrows money from crowdfunding for a return of 10 % to 16 % p.a.? 

It mixes its own resources, resources from crowdfunding and resources from banks in such a way that he is left with a decent return at the end of the project.

I'll explain. The bank needs to see that it is going into the project together with the developer in a ratio of at least 30 % developer and 70 % bank. 

Example:

• 10 % Developer's own resources
• 20 % is borrowed by the developer from crowdfunding at e.g. 15 % p.a.
• 70 % is borrowed by the developer from the bank for e.g. 5 % p.a.
• The developer has a mixed bag of money in his hands with an interest rate of around 6.5 % p.a. - which is, after all, already an interest rate with which you can generate interesting returns.

Without crowdfunding, he might not have been able to "kick-start" the investment plan. Sure, he can borrow from a neighbor, brother, sister, family, friend.

Often these "kickback" loans spill over into a group of people who have been developing for decades. Jano lends to Fer. Fero at the next project, he'll lend to Jano. Now... And they develop amongst themselves. They make money on loans to themselves. They make money on the projects. The bank makes money. 

Try to be among the people who implement development projects. You will find it very difficult.

And real estate crowdfunding is a way for ordinary people to participate in small amounts in an investment project and achieve a very interesting but fair return. Fair because without their support, the project might never have happened.

Banks like big projects ... at least over 1 million in costs.

Maybe you have only now understood how the real estate business works and decide to undertake such a project yourself. I will, of course very happy if you succeed. Well, if you plan to build a smaller project, under under the 1 million euro cost threshold, you're going to have a big problem at the bank.

It's a very small fish for them to give you their time. You have to understand that banks finance construction in the order of millions, in the tens of millions to hundreds of millions of euros. Where that yield is really interesting.

What if a developer wants to do a small project?

The developer wants to do the construction of 3-4 houses in the cost about 400 thousand euros. The bank with its project financing will most likely most likely will not help or lend.

What then?

He has to help himself. Or, if the economy permits, he can use Crowdfunding. You can sell three or four houses within 12 months of construction. In crowdfunding, you can schedule your loans in stages so that you are not left with "dead money" in your account for which you will pay interest. 

Example:

A developer buys 2,500 m2 of land worth e.g. 125,000 euros, this can be his deposit. It is not a condition. He schedules his first loan from crowdfunding for January worth 100 000 euros with an interest of 15 % p.a. He builds the foundations for 4x houses and waits 2 months as the experienced master tells him to.

Already at this stage, the developer can start doing pre-sales. The money from the pre-sale will be used to complete the houses after agreement with the buyers. This will cut off the next loan from crowdfunding and save on interest.

In case the presale does not do...

Sometime in March the developer can boldly apply to crowdfunding for another loan of 200,000 euros at an interest of 15 % p.a. He will finish his construction and start selling 4x holodomes for real. ️

Can the month of August be? Pleasant weather, the sun's rays are already leaning on the new beautiful houses with garden. If the developer has built it in the right location at the right price, I have no doubt that the houses will sell by the end of the year. If he hasn't already sold them during construction, or just after.

How much will the developer pay for the crowdfunding interest?

• on the first loan of EUR 100 000, he pays EUR 15 000 in interest (15 % p.a. interest payable in 12 months)
• on the second loan of EUR 200 000, he pays interest of EUR 25 000 euros (15 % p.a. interest payable in 10 months only)
• Total annual interest 40 000 euros for 4x houses. 

In my location with these parameters, the developer will sell 4x houses for 600 000 euros without VAT.

The result?

Cost €125 000 + €100 000 + €200 000 + €40 000 = €440 000. Let us add a reserve of EUR 35 000. Let us be careful and it will be easier to calculate.

So...

Sales 600 000 euros - costs 500 000 euros = 100 000 euros profit excluding VAT before tax. Decent, right? 

How much of the developer's own resources were invested at the beginning of this project? 125 000 euros per plot. The result after 12 months? 100,000 euros profit, that's a return of 80 % p.a. on the deposit already after the crowdfunding return! 

Why didn't the developer borrow from the bank at a lower interest rate?

The bank will not lend to him for smaller projects. Well, if he prepares the economy thoroughly and times his crowdfunding loans right, he doesn't need a bank at all. The developer makes money, the investor makes money. And everyone is happy.

For larger projects, the developer can mix the money sensibly so that everyone makes money. It's a WIN-WIN-WIN situation. Investors, developer, bank. 

And the WIN-WIN situation is the reason, why real estate corwdfunding is so successful. Everybody will benefit. 

Without investors, without you investing through real estate crowdfunding, the investment plan might never have come into existence. And that's why every single investor deserves a fair return on their project. 

I'm keeping my fingers crossed for you on your passive income journey.