The reasoning behind Ladder
The key parameters we listed were
- Are we solving a real problem and who is suffering the pain
- Can we control outcomes
- Short sales cycle, higher transaction velocity
- Transaction size and ability to underwrite enough transactions to get the platform to take off velocity
- High return and relatively safe
- Scalable through use of technology and capital
- Sticky and cumulative revenues
- We have an undue advantage in execution
- Lower complexity
- Revenue generation should be faster and front loaded
- Easy to establish secondary market
The model which Estate Baron worked off was to help real estate developers raise equity funding for their development projects. A clearly defined problem for which clients are willing to pay money for provided we can actually solve it.
But as explained in earlier articles, fundraising for development projects is quite hard. Amounts are large, outcomes take longer to deliver which means transaction velocity is low. Plus you are reliant on 3rd parties to do what they said they will do without any meaningful control. All of these and several more issues mean doing this in a scalable manner is quite hard.
There is a small opportunity in the market for people who want to use their existing networks and our tech and compliance solutions in a whitelabel manner, but this is hardly the basis of a long term scalable business.
If we want to make this work, we have to reduce uncertainty out of the development process and in order to do that we need to turn the model on its own head.
The typical process of development and a developer working for fundraising works a bit like this:
- Developer identifies land and puts a deposit on it
- He starts the process of getting plans approved from council to suit his development (in certain cases the site is bought with plans)
- Once plans are approved, the process of presales starts
- Around this time land settlement time comes through
- The developer typically settles the land at this stage using bank borrowings or other sources using a first mortgage. Typically the loan would be 70–80% of land value.
- The remainder typically comes from the developers pockets.
- At this stage in order for the project to progress, the developer needs construction lending
- A bank or a senior lender would need to see a certain amount of presales before they lend the construction money. The presale amounts vary but a bank will typically want around 100–110% presales to be achieved before they lend the construction money
- Achieving presales requires marketing money and once presales are achieved half of the commissions need to be paid to the sales agencies. All of this money comes from the developers pockets.
- Once this achieved, rest is usually smooth sailing. Construction financing comes in. The build hopefully goes unimpeded and in due times sales settlements come through and the developer is left with a healthy profit.
In effect the contribution from the developer is for
- Land deposit
- Plans and permits expenses
- Marketing fees
- Sales commissions
Assuming the developer has already put the land deposit, the remainder funds which he needs are for plans, marketing and sales. And that is where he looks to use 3rd party equity funding solutions such as Estate Baron for.
The challenge for an investor here is that the project is way too early still and the outcomes are uncertain. In the lack of presales the investors are without a clear exit strategy and their outcomes are bobbing up and down on the ocean of uncertainty.
What if we anchored down the exit strategy instead by assisting the developer with the presales first?
If we can firm up presales, then the exit is clearer.
Sufficient presales also means the difference between high and low cost construction lending which can be in the tune of hundreds of thousands, if not millions of dollars.
If we can have clearly defined exit strategy then selling it to investors as equity participants in the project is also much easier and safer.
All in all we need to start by doing the last thing first. Firm up the sales first and then work backwards.
So how do we do that?
Especially in a market that is becoming harder and harder for sales? Banks are tightening lending criteria and settlements are falling over.
The answer is in every crisis lies an opportunity.
We will focus on the first home buyer market and land sales first.
The biggest challenge this segment of buyers has is that they do not have enough money saved for a deposit. They will often have a job and serviceability but will not have the money to cover the initial 5 to 10%. By the time they save enough the property market often moves out of their reach.
We propose an AfterPay like solution, where we front the deposit portion of their contract and get them onto the contract.
This would not be a loan, it would be interest free to the buyer.
We would charge our sales comms to the developer which would form our revenue. Getting enough of these would also mean that we can influence who the construction lender would be and also get a clip from the brokerage associated with that.
The buyer then goes on a savings plan over the 12 to 18 month duration of the project and saves the money required for the deposit. At the end of the construction period they would have saved the required sum to cover the deposit.
Note that we would qualify the buyers to ensure that they have the preapprovals sans savings at that stage to qualify for the loan they expect at the end of the development phase.
It is a model that saves the developer the upfront money required for achieving a sale and yet achieves outcomes in an efficient manner.
We only need to deploy between 10–30K per sale and we get multiple revenue streams including sales comms, brokerage fees for the project, builder commissions (for house and land packages) and also a potential clip on the home loan for the buyer.
Plus now we have made the project a far more certain proposition making it safer for investors such as those via the Estate Baron model to participate in.
We intend to create an investment product specifically for this purpose to enable us to pay for these presales and roll it out as a solution for developers all around Australia starting Melbourne first.