According to Wikipedia, “Sweat Equity” is defined as: a party's contribution to a project in the form of effort and toil, as opposed to financial equity such as paying others to perform a task.

Sweat Equity is normally initiated as a cost saving exercise, where in the case of property development, the developer shoulders the task of achieving the “highest and best use” for a property. Whilst this will often involve the collective efforts of industry professionals such as architects and town planners, it is almost always in consultation and at the direction of the property developer that first identifies the opportunity, and at the end of the day will speculatively outlay the cost of engaging such professionals.

So when does sweat equity via uplift in land count?  

It should not be overlooked that in many cases successful developers are already on the path to creating sweat equity in negotiating a Vendor to a price that recognises the current “value” of a site based on its highest and best use today, versus what can be achieved in the future. Taking strategic control of a property through an option agreement or instalment contract while you work up an appropriate town planning or design strategy can also provide potential uplift which can later be included as part of the developers sweat equity.

That sweat equity effectively represents the uplift in value that is created without changing the visual presentation of a property. It should also be noted that a change in market conditions and specifically a rising market should not be construed as sweat equity where these changes occurred over a long period of time or were unrelated to the developers strategy to redevelop the property. Buying a property at the bottom of the market and holding it through an improving market in the hope that it will improve in value is not sweat equity. 

Quantifying sweat equity in terms of property will normally be proven or measured by comparing a purchase price or value at a point in time to the current value of the property at the point in time where that sweat equity is required to be assessed for the purpose of securing a funding outcome.

In most respects HoldenCAPITAL and prospective lenders view on sweat equity is similar to that of a valuers, on the basis that it is an art not a science. It requires an analysis of things like the market, the developers experience in undertaking a project of that size and scope and the planning and research they have put into conceiving the project (i.e. not just dumb luck), as well as the time and costs incurred including the retention of appropriately credentialed professionals engaged by the property developer. To further define sweat equity we think it is important to qualify it by suggesting that it is value created that was perhaps not obviously apparent and easily achievable by the “common man”.

To use another art analogy, “one man’s art is another man’s trash”. Whilst this is perhaps a little extreme, it is fair to say that while most Lenders will recognise the sweat equity others, for reasons known only to them, will not. It is therefore, extremely important to clearly articulate the effort and contributions that have been made by the developer in order to justify the quantification of their  “sweat equity” when the valuation uplift is being assessed.  

It should also be pointed out that hard work and the expending of cash equity will not always result in an uplift in valuation.

Some examples of sweat equity can include but are not limited to:

- a change in permitted use of the property;

- rezoning;

- changes in planning such as increased heights, configuration allowances, product mix;

- a change in design of the proposed redevelopment; and

- amalgamation of adjoining sites.

This is an area where developers often fail to accurately articulate where their sweat equity has been added so that it should be recognised by Lenders. Seeking advice from an experienced Construction Finance Broker can ensure that this doesn’t happen and make a significant difference to the final equity contribution the developer is required to contribute.

This article was written by Dan Holden of HoldenCAPITAL, a bespoke construction finance firm. HoldenCAPITAL arranges construction finance and invests in projects through their equity trust, Queen Street INVEST. To discuss your project finance requirement please call (07) 3171 4200 or visit www.holdencapital.com.au.

For more advice from Dan Holden of HoldenCAPITAL, see:

From DA to digging a hole

Diversify your risk by partnering as a passive investor

What is mezzanine funding?

Why the banks fear foreign pre-sales

Risk & reward: Does more debt solve your problems or do you need a JV partner?

Don't forget your GST obligations when arranging your project finance

Why the bank won't let you have a second mortgage