The Perils of 100% Debt in Property Development | Monday Morning Musing #15

Debt is a powerful tool, but only when used wisely. It can boost your returns significantly or wipe you out completely.

It’s tempting for developers to finance their entire capital stack with debt instead of offering equity in exchange for funding. After all, why give away 50% of your profit or 20%+ in returns when you can borrow the full amount and give away a fraction? The answer is simple…building your capital stack with pure debt carries serious risks.

When debt makes up 100% of the funding, there’s little/no room for error. Everything must go perfectly. From low build costs to strong sales, and ideally a rising market. But what happens when costs creep up or sales slow down? Margins shrink, profits turn to losses, and developers find themselves in trouble.

At that point, the choices aren’t pretty: inject more cash, raise more debt, rush a sale, or face insolvency. This can create a cycle of over leveraged projects, mounting liabilities, and, in extreme cases and more common than most care to admit, an unintentional Ponzi like scenario where new debt is used to cover old losses.

The takeaway? Developers should be cautious with high leverage deals and stay attuned to market conditions.

And investors, always review the balance sheet of those you are investing in. Scrutinise assets and liabilities, and don’t dismiss the benefits of taking an equity stake for better long term returns. A well structured deal today can prevent major headaches down the line.

If you must go the 100% debt route (after all, we are all adults) just ensure you’re fully aware of the risks.