Development Finance
How does development finance work?
Property development finance assists with funding a residential or commercial development. Unlike regular home or commercial mortgages, where a loan is taken out to buy an existing property, development finance is used to build a new property or to renovate or convert an existing property. Because the development property does not yet exist (new-build), or it is going to be significantly changed from its current condition (refurbs and conversions), development loans are granted on the cost of the development as well as the projected future value of the property when it has been completed. In all cases, LTC (loan to cost – the size of the loan against the total deal costs) and LTGDV (loan to gross development value – the size of the loan against the end value of the property once constructed), the borrower’s previous track record in the sector and their ability to repay the borrowing are all considered during the assessment of loan applications.
With development loans, interest is usually rolled-up or capitalised. This means that the interest charged by the lender is added to the loan balance rather than paid as a monthly instalment. This means there is no drain on cashflow during the construction period and the total interest charged is paid when the properties are sold or refinanced to repay the debt.
Types of development finance
Development finance facilities are all unique, there is no one size fits all facility. They are tailor-made products specifically designed for different types of development and created bespoke for each scheme a developer undertakes. Development finance loans can be used for the following purposes:
- Residential property development
- Commercial/semi-commercial property development
- Renovations/conversions/refurbishment
- New builds
- Single-unit developments scaling up to large multi-unit schemes
- Development Exit Funding (sometimes called Sales Period Funding) – similar to a bridging loan and typically used to finance a recently completed development until the units are sold or refinanced on a longer term loan facility.
- Regulated development finance –most development financing is unregulated, but it becomes regulated when more than 40% of the development will be used as a residential dwelling by the borrower. Regulated loans provide consumer protections governed by the Financial Conduct Authority (FCA).
- Mezzanine development finance – a secondary line of borrowing for the same development. Usually used to reduce the need for a large cash deposit. Sometimes called a ‘junior loan’ or a ‘junior mortgage’.
Some development projects may require a mix of different loan products, (for example, new-build mixed with conversion of an existing structure), or the developer (borrower) may be unsure as to which kind of financing to apply for. Professional opinion is advised in such circumstances. Contact us now to discover what type of financing is best for your project and our experienced and knowledgeable team will guide you through the whole process.
The process explained
There are multiple steps in any development finance deal. A typical transaction looks like this:
- Initial enquiry – free advice – formal application submitted to lenders when the time is right
- Lender provides an agreement in principle – indication of terms and conditions
- Lender conducts due diligence, which may include a site visit and/or valuations
- Projected future value of development delivered
- Lender makes formal loan offer – accepted by borrower
- Lawyers create documentation – signature by all parties – exchange of contracts
- Completion – first drawdown of funds to buy land or start construction
- Additional drawdowns to fund build costs
- Repayment of loan – usually when the development is sold or refinanced
Most lenders will require a substantial file of documents from the borrower at the time of application, however we work with our clients to make this process as painless as possible. Having all your ducks in a row will enhance the potential for successful project funding. Every lender will have their own proprietary criteria for documentation, but key paperwork includes:
- Details of planning permission and any drawings
- Details of any planning restrictions or levies that may impact project profitability
- Complete breakdown of all project costs
- Details of borrower’s development experience and examples of previous projects
- Schedule of works (operational calendar) broken down by phases
- Details of architects, contractors etc.
- List of borrower’s current assets and liabilities, plus projected expenditures during the life of the project
- Proposed exit strategy
- Projected gross development value – what will it all be worth when completed?
Whilst experience is preferred for most lenders, if you’re a first time developer there are options available to you too. Request a call back from one of our Commercial Finance Managers to understand the options available to you.
How much can I borrow?
Development loans start from as little as £200,000. Different lenders have various upper limits. Our team of experts can provide you with options up to £50 million.
What are the interest rates?
Interest rates vary from 4% to 15% APR, however, as development loans are short-term, the amount of interest charged is of lower importance to the borrower than the total deal costs (fees, etc) and the loan covenants (terms and conditions), that a lender will insist upon. This is where our team of Commercial Finance Managers will guide you through the various options available to you. The cheapest rate isn’t always the most competitive overall deal.
What fees & other costs are involved?
Fees vary according to each loan and the specific set of circumstances surrounding the deal. Typical fees included in development financing are:
- Lender arrangement fee – a charge from the lender for providing the finance.
- Broker arrangement fee – a charge from the broker who functioned as intermediary between borrower and lender, as well as any other professionals involved in the deal.
- Monitoring surveyor fees, (sometimes called Quantity Surveyor Fees, or QS) – costs to maintain professional surveyor oversight of the development to ensure it complies with building regulations and deal covenants during the term of the loan.
- Exit fees – a charge applied when the loan is paid off.
- Legal fees – lawyer costs and fees.
- Non-utilisation fees – interest is usually charged only on the sum of money drawn from the loan pool. Some lenders may additionally charge a non-utilisation fee to compensate them for funds they have made available to the lender, but which are left unused and not earning interest.
- Management/admin fees – office costs and fees to manage the loan.
An example
Unlike regular home or business mortgages, development loans are paid out in stages from an agreed loan pool. Lenders will typically limit the funds they are willing to provide to no more than 70% of land purchase costs, and up to 90% of the construction costs.
Here’s an example of new-build development finance:
- A plot of land has been sourced that has planning permission to build ten, three bedroom detached houses. The land can be purchased for £600,000 and the cost to build all ten houses will be £2,000,000. Total deal costs are £2,600,000, (ex. fees and interest).
- The estimated value of each house after construction (including their freehold), is £350,000 meaning a Gross Development Value (GDV) of (10 x £350,000) £3,500,000.
- Development finance can be used to raise up to 70% of the land cost = £420,000 and 90% of the build cost = £1,800,000.
- A loan facility is set up for £2,220,000. (The pool). Funds are released in stages, with an initial release of £420,000 to help buy the land. The developer will provide cash in the sum of £180,000 to complete the land purchase.
- The remaining £1,800,000 will be released in stages as the new-build progresses. The borrower will use their cash first, with the lender then following with further drawdowns.
- The borrowed sum of £2,220,000 plus interest is repaid when the houses are sold on completion. As this deal is not a joint venture, the developer retains all the profits.
With most development loans, interest is only charged on funds that have been drawn from the loan pool.
100% development finance
Most UK property development finance options cap out at a maximum of 60-80% of the total deal value. However, 100% development finance may be achieved if: 1). The borrower enters a Joint Venture with a financier who is willing to provide lending to the total deal value in exchange for interest and a share of the profits. 2). The borrower offers additional collateral as make-weight security in lieu of a cash contribution.
To find out if 100% financing is an option for you, please contact us today.