Development Finance Complete Guide 2017-06-06T14:43:57+00:00

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The Complete Guide to Development Finance

Last Updated 10 May 2017.
Using the index below, click on a link to scroll down to that section.

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Introduction

Property development finance is a very specialist market and information online can be conflicting making it difficult to understand what is available. The market can seem quite unapproachable from the outside, with information about your options closely guarded.

Development finance is used generically but tends to cover a huge number of options from ground up development to property refurbishment and conversion of property. We will use this guide to give you the full picture on property development finance. We’ll arm you with useful information and tell you what you need to know to get started. We will cover the following:-

  • What is property development finance
  • What interest rates are realistic and how will I achieve them
  • How long does development finance take to complete
  • How staged drawdown works
  • The costs involved in property development loans
  • What do lenders look for in an application

Alongside these key points, we will cover the other product features and points to consider before taking out property development loans. Let’s get started…

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What Is Development Finance?

Property Development finance is a type of funding used to fund the construction, conversion or heavy refurbishment of buildings. The loan is usually set up as a short-term loan to fund from start to finish of the project, prior to sale or refinance once the property is complete and ready for occupation.

Property Development finance is often broken down into 2 distinct parts. The first is to fund the purchase or refinance of the site, secondly, the lender will release funds for the build. The funds for the build are generally released in stages, which we will cover in detail later in this guide.

Given the range of projects, development finance is used by many different types of lenders. Whether a full-time property developer, a company, a self-build enthusiast or a private individual with an opportunity, property development finance could be right for you.

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Housing Market – Need For New Homes – Quote RICS Or Similar Stats

Housing in the UK is at a premium with historically low levels of new homes being built and a soaring demand. Although there have been signs that the building of new homes is beginning to increase, there is still plenty of demand for more. This difference between supply and demand of new housing stock provides a significant opportunity for property developers.

As buy to let rules continue to tighten, property investors are beginning to look at other options such as commercial property investment, refurbishment projects and HMO properties. Property development is a natural next step for those looking to increase their returns from property investment. Whether you’re looking to build to sell or let, the profits can be huge.

As an experienced portfolio landlord, the uplift in value on a well-judged development has the same effect as buying significantly below value. Your net yield on the let property will increase, meaning more money left over after the mortgage has been paid.

We’ll now look at how the process works and some product details.

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Choosing The Right Development Finance Institution

The application process involves providing quite a lot of information and as such it’s important to take a structured approach to providing what’s needed. The key decision here is whether you use a reputable development finance broker or approach lenders direct.

An experienced development finance broker will understand the market and work with you to ensure you achieve the best development finance rates for your project. When placing you with a suitable lender, your broker will take into account key facts about the whole situation such as your experience, site location, the development itself, and an exit plan. They will then provide help around formatting your costings and other required documents in the right way. It is important that everything is well presented to the lender to increase the likelihood of the loan being accepted.

Development finance lenders will look at applications very differently and will work to different levels of risk, pricing each loan individually. As a result of the individual underwriting of loans, there can be a big difference in the rates charged by different lenders, meaning it’s important to not accept the first offer you see. Comparing the whole market is important if you’re keen to keep costs to a minimum.

Obviously researching and talking to each lender can be time-consuming and as such, a reputable broker can save you a significant amount of time.

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What Is The Application Process?

The application process runs as follows:-

  1. Before talking to anybody, you will need to work out a rough idea of costs, end value, profit margin, how long the project take and viability.
  2. You will then discuss your needs with either a lender or broker who will talk through the project to assess the project.
  3. Assuming the scheme is viable, you will then receive a quote in writing detailing the interest rate, fees and headline borrowing terms, along with what documents are required to submit a full application.
  4. The documents will be completed and submitted to the lender (if submitted through us, they will be submitted alongside a comprehensive report on the project).
  5. If the lender is happy with the project so far they will want to meet you and visit the site. This helps to understand the project and build a relationship between you and your dedicated lending manager. We will work with you to arrange the site visit and will usually attend to help you to answer any questions.
  6. After the site visit has been completed, your lending manager will usually take your application to the credit committee. These are the underwriters who sign off the application as acceptable to the lender. Once approved, the lender will issue the formal offer, subject to valuation and legal work.
  7. A surveyor is instructed to compile a valuation report on the project. It will be comprehensive, covering the current value, anticipated build costs, anticipated gross development value and expected demand.
  8. Your solicitor is instructed to carry out the legal work and satisfy all conditions. They will run through the terms of the agreement and ensure you fully understand the loan. Once satisfied, you will sign the formal offer and return it to the lender. It is important that your solicitor is experienced in dealing with development finance as inexperience here can slow the process down significantly.
  9. Once all of this is done, the funds can be released and the loan completed. Note that only the first stage of funds is released to your solicitor. There is more information on the staged drawdown below.

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Documents Needed To Apply

To apply for property development, you will usually have to provide the full plans, costings and your development CV. In addition, the lender will require details of your current asset, liability, income and expenditure position and recent bank statements.

Most lenders will have an application form to cover some of the details required, but a comprehensive report detailing your position and the full picture of the scheme is recommended. Most experienced development brokers will write a report on your behalf once they have the details and costings needed to put the details together.

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Loan Sizes, Terms And Interest Rates

Property Development finance covers such a wide range of projects. Minimum loans tend to start from around £50,000 with no real defined maximum. Projects can run into hundreds of millions, or even beyond and lenders will be happy to fund at this level, subject to demand.

Tip: Minimum loans tend to start from around £50,000 with no real defined maximum. Projects can run into hundreds of millions, or even beyond and lenders will be happy to fund at this level, subject to demand.

Property development loans are designed to be used as a short-term loan, funding only during completion of the scheme. Once completed, the loans are repaid, generally, through the sale of the property or refinance on to a longer term loan.

The maximum term across the market is 48 months, with the vast majority of lenders offering loans up to a maximum of 18-24 months. Any loans that will be required for more than 24 months are likely to restrict the number of lenders willing to accept the application and could, therefore, increase the interest rate and fees charged.

The interest rates offered by lenders vary a great deal across the market. Experience, loan amount, site location and the amount of loan to gross development value (GDV) play great roles in deciding the rate charged. Smaller loans, usually below £500,000 tend to pay a higher rate due to the amount of work involved in managing a project. Loans tend to start at around 4.75% per annum, however, this is extremely rare. A loan of above £500,000 to an experienced developer at a loan to GDV below 70% would most likely be charged between 6.5% and 9% per annum depending on demand and quality of the scheme. For smaller or higher risk loans, a rate between 0.85% per month and 1.35% per month (10.2% to 16.2% per annum) is more realistic.

Tip: A loan of above £500,000 to an experienced developer at a loan to GDV below 70% would most likely be charged between 6.5% and 9% per annum depending on demand and quality of the scheme. For smaller or higher risk loans, a rate between 0.85% per month and 1.35% per month (10.2% to 16.2% per annum) is more realistic.

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What Fees Am I Likely To Have To Pay?

Lenders tend to charge a number of fees, for ease, we have broken these down:-

  • Arrangement Fee – The arrangement fee, often known as the facility fee is usually charged by the lender as a set-up fee for the loan. It is generally between 1-2% of the loan.
  • Valuation Fees – As mentioned above, the lender will instruct a valuation to complete a report on the development. There is no set valuation fee and but it tends to be higher for more expensive schemes.
  • Professional Fees – On top of the valuation fee, other professionals are likely to be needed and of course they will charge for their services. Expect to pay out for architects, quantity surveyors and solicitors. Depending on the scheme you may also need to pay for project managers and monitoring surveyors.
  • Exit Fees – This is not charged by all lenders, but the majority do. The fee is payable to the lender when repaying the loan. Generally, the charge will come in at 1-2% of either the loan amount or GDV. It is important to understand what your exit fee is charged against as the difference between a charge against loan amount and GDV can be significant as the example shows.
  • Broker Fees – Brokers often charge fees for the finding the best lender and managing your application to completion at the best possible terms. Some lenders will pay the broker a fee for successfully placing the application with them (usually 1%), while others will pay nothing. At ABC Finance, we usually expect to earn 1% from a successful development finance application, which will mean we wouldn’t generally charge a broker fee if the lender pays us. We would generally earn slightly less if the loan is particularly large based on a judgement of income needed to cover the work required to complete the application. We always agree on any broker fees upfront and charge only once the application is successful. We never charge upfront fees to submit your application.

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LTC, LTGDV & Ongoing Position, Cash Flow, Stage Release Payments

The maximum loan on property development finance applications is decided using several factors. Unlike traditional mortgages that are able to use the loan to value to determine the maximum against a property of a certain value, development finance has to use several calculations. They are:-

  • Loan to cost (LTC) – Loan to cost – LTC – is a metric used to compare the amount of loan offered as a percentage of the total cost of building the project. Loan to cost often comes in at between 80-100%. 90% LTC is common subject to meeting the criteria around loan to GDV. E.g. if the construction costs are £500,000, 90% LTC would be a loan of £450,000.
  • Loan to gross development value (GDV) – The loan to gross development value is the maximum loan expressed as a percentage of the GDV – the value of the project once completed. Excluding joint venture development finance, the maximum loan to GDV available currently is 80%. E.g if the completed build value is £1m, the maximum loan to GDV would be £800,000.
  • Day 1 position – Lenders will always look at the amount of money they are expected to release upfront to get the project moving and purchase the site. The maximum available is generally 65-70%, with more sometimes available if suitable additional security is offered.

The lender will look at the metrics above and will lend based on the lower of the loan to cost and loan to GDV. While the headline maximum loan will be based on these figures, the day one figure and the ongoing cash flow of the scheme is just as important.

The difference between the total loan and the amount released on day 1 is released through stage payments throughout the build rather than in one amount.

Before each stage payment is released, the lender will usually instruct the surveyor to re-inspect the site to ensure the work has been completed to a satisfactory standard. They will also want to ensure your project is progressing well and is on track. Your offer letter will state the cost of the re-inspections clearly and you need to account for this cost as part of the overall cost of finance.

The lender will look at your costings and take the opinion of professionals to ensure your cash flow is not compromised throughout the build and for the timing of stage payments. It is important that your costings are as accurate as possible because they will be used to project likely points for staged drawdowns.

A form of protection will usually be inbuilt through insistence on a contingency fund. A contingency fund is an amount of money set aside to cover delays or unexpected increases in costs. Property development is a complex undertaking and as such a contingency fund is an essential consideration. The larger your contingency fund, the more unexpected costs you can afford to absorb, making the transaction much safer.

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Repayments During The Build

Rolled up or retained interest are terms used when monthly interest on property development finance are rolled up on top of the loan amount, rather than paid monthly. Any rolled up, or retained interest will have to be accounted for in the loan to GDV. This is something you will have to factor in when calculating the maximum loan.

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Location Key For Lenders, They Look At Demand

Development finance lenders base their decisions on the risk of an application and the ease of repaying the debt once the project is completed. When considering how the debt will be repaid once completed, 2 factors tend to come into play. If the property were to be let, would the amount of debt be available on a buy to let mortgage? Secondly, if the property were to be sold on the open market, how much demand would there be? If the demand is low then it could take a significant amount of time to sell. Equally, if the property is particularly lavish for the area it’s situated in then willing buyers may be unwilling to afford the property, even if they want it.

The laws of supply and demand are equally strong with property as any other area and a property is only worth as much as a willing buyer can pay. As a result, lenders will consider market forces and the likelihood of a sale occurring in a timely fashion before committing to a project.

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How Important Is Previous Property Development Experience?

Previous experience is important from a lenders point of view. A lot of lenders are keen to see details of your track record before committing to a loan. There are, however, lenders who will accept a first-time developer if they appear capable of completing the project.

For many new developers, there are 2 major routes to achieving success on your first development finance application. Firstly, experience of refurbishment and extension of existing properties, with value added. Secondly, a lender may accept an application from a first time developer with significant experience around them – e.g. Architects, builders and a project manager.

Having experienced people around you doesn’t replace personal experience, however, and many lenders would still be uncomfortable. This will most likely make the lowest rates out of reach, but the potential to lend will still be there, especially if you already have a strong asset and income profile.

Asset and income positions are important on all applications as lenders want to know there is a back-up in case things don’t go according to plan. As with contingency funds, the more background assets and income, the safer the application is considered to be.

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Is There A Difference Between Property Refurbishment Finance And Property Development Finance?

Yes, property development finance and property refurbishment loans are for distinctly different situations, although they are closely linked. Property refurbishment is usually judged on a sliding scale from light refurbishment through to heavy refurbishment.

Light refurbishment will cover standard internal redecoration with no structural works required. Usually, light refurbishment applications will not require planning permission or building regulations. Generally, a light refurbishment product will involve only minor work such as general redecoration, new kitchens and bathrooms and new windows. Any work beyond this sort of level is likely to fall move toward heavy refurbishment, which allows for more complex work to be undertaken but also tends to cost more.

Heavy refurbishment will allow for structural changes to be made to an existing property and may require planning permission/building regulations. The more complex the works become, the higher the interest rate becomes. You may also find the loan to value reduces as you move toward more complex work.

Like property development loans, refurbishment products tend to provide funds in 2 tranches. The first is the initial advance, based upon the purchase price (for a purchase) or valuation (for a refinance) of the property. Light refurbishment products tend to be available up to 75% of the property value.

Heavier refurbishment loans tend to increase in costs and reduce in loan to value as the works increase. Generally, a loan to value of 70% can be expected, although particularly complex works may be restricted to 65%.

The second tranche is released to you for completion of the works. This tends to be based on the end value of the project. It is possible to borrow up to 100% of the cost of works, assuming a reasonable uplift in value is achieved.

Rates on short-term property refurbishment finance tend to start at around 0.6% and will increase as the amount of work involved increases. Rates tend to be lower at lower loan to values as with traditional mortgages, as you move toward 75% on a light refurbishment, rates will start from 0.75%.

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Residential Development Finance

If you’re looking to build your own home, there are 2 different products that are able to cover this. Firstly, you can take out regulated development finance. The ‘regulated’ part makes reference to the fact the loan is regulated by the Financial Conduct Authority (FCA). Development finance applications become regulated if 40% or more of the property is to be used as or in connection with a dwelling.

Regulated development finance works in much the same way as unregulated, but the lender will be careful to ensure the exit is realistic. If you plan on refinancing to a standard mortgage once the property is completed, checks will be done to ensure this is realistic. The lender will only release funds when they are confident that other lenders will accept the refinance.

The number of checks you have to pass may also increase slightly. The effect to you is that the application will take slightly longer, although the regulation shouldn’t make the application onerous. If you’re unsure whether you plan to live in or sell a property once built, it’s important that care is taken. You have to be clear before application that you may intend on living in the property and it would be advisable that you treat the application as if you will live in the property, even if you’re unsure.

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Funding Yourself Through Planning

Most development finance lenders will want planning permission to be in place before they will consider lending. Often, developers will purchase a site to take through planning, before the eventual development. This process can take months and can be complex and expensive.

The gap in funding between purchase and the granting of full planning permission can be difficult to cover. If you don’t have sufficient funds to cover this period, you may need to take out a bridging loan to cover the gap. Bridging loans are a short-term route to raising the funds needed to purchase your site.

Bridging loan lenders won’t release any funds for the works on the property and would expect you to refinance as soon as planning permission is granted. Generally speaking, you will be able to borrow between 60-75% of the value of the site, depending on the type of property purchased.

The image shows the likely maximum loan to value for residential and commercial property and land with or without planning permission. Residential property usually has a maximum LTV of 80% and sits at the top of the scale, with land usually able to raise a maximum of 65% of its value through bridging finance.

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Joint Venture Development Finance

Joint venture or JV development finance provides experienced developers with all the funds needed to buy and build out a project. With 100% loan to cost funding, you will enter into a profit share with the funder, who could be a traditional lender or a private individual.

Usually, the applicant and joint venture partner would set up and SPV (special purpose vehicle) Ltd company, or a profit share agreement. The profit split is usually 50/50.

There are several key factors to securing joint venture funding. As all the financial risk is taken by one party, they will be keen to ensure no problems occur. As such, joint venture funding only tends to be available to experienced developers with a demonstrable track record of completion of sites of a similar level of complexity to the site offered.

JV investors will not usually accept any element of planning risk and as such will want to see planning permission in place before funding. This means any site which would need to be taken through planning would not be suitable for JV funding.

Costings are extremely important and any JV partner will want to ensure the costs do not overrun. Upfront analysis of the costings will be detailed to minimise risk. In addition to the checks around costings, the investor may insist on guarantees for cost overruns from the developer as an additional safety measure.

Maximising returns is the key factor and the level of anticipated uplift on a potential development can be make or break. As the potential return increases so does the likelihood of the application being accepted. Although a profit of 10% for little work may seem appealing, the danger of unexpected costs may be too high for a JV investor. Typically, a profit after all costs of 20% is the minimum required to achieve 100% funding.

Tip: Joint venture or JV development finance provides experienced developers with 100% loan to cost funding. In return for having the entire cost of the project funded, you will enter into a profit share with the lender.

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Exiting Your Property Development Loan

As development finance is designed to be a short-term product, your method of repayment is very important. When working on a short-term product like this, it’s important to ensure you have made allowance for any delays. If you settle for the shortest possible term, you could well run out of time.

During a build, external factors can delay you, such as bad weather, obtaining materials or delays caused by your builders. When facing a delay of this nature, your build will be pushed back and may not be able to catch up. As much as a cash contingency is needed, a contingency of time is also important.

Adequate opportunity to sell must also be accounted for as any attempt to sell quickly will usually drive down the sale prices. Failure to repay your development finance on time will result in additional costs occurring, with more interest than budgeted for becoming due and additional charges for extending the facility may become payable.

It is not always possible to extend your property development loan. Failure to repay can cause serious issues and can even result in loss of the property. Adequate planning and understanding of the risks is a must before taking your loan out.

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Reasons For Delays

There are several factors that delay property development loans and often, the same issues will crop up. Here are our 3 tips to ensure the loan runs quickly and smoothly:-

#1 Choosing the right solicitor – Choosing the right solicitor is crucial to ensuring the property development loan completes in a timely fashion. A solicitor who is experienced in dealing with development loans will ensure the legal process runs quickly and without issue.

Your solicitor will act as the sole liaison between the lender and yourself when it comes to your understanding of loan. They play a very important role ensuring the legal work is all completed to the lender’s satisfaction. With this in mind, it is advisable that your solicitor is well versed in dealing with property development.

#2 Incomplete or inaccurate costings – The costings are of absolute importance to the application. Property development can be difficult to manage when working with perfect figures, and things will tend to crop up no matter how well planned the project is. However, if the figures aren’t right initially, the chances of the project becoming a loss maker increase significantly.

Where the figures seem to be missing detail or are inaccurate, lenders will tend to take issue. This could result in a declined or heavily delayed application.

#3 Delays in providing the paperwork – When a lender asks for information, it may not be easy to provide. However, keeping the application moving forward is important. If there is a delay in providing things when asked for, the application tends to slow down from the lender’s side also.

When faced with constant delays, the whole process slows down and an application can tend to sit at the bottom of the pile. This is not true of genuine delays, but a constantly slow reaction to requests from the lender can indicate a lack of commitment (whether correct or not) and will result in a slower completion.

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Conclusion

Property development finance is complex and lenders tend to have their own niche and look for very specific applications. Finding the right lender can be difficult and the additional cost for failing to find the perfect fit significant.

On top of finding the right lender, presentation and management of the application are of paramount importance. Securing the most favourable terms, projecting cash flow and ensuring the drawdown schedule is realistic is crucial to the build. Confidence in handling all of these factors is very important.

Getting all the facts upfront can be difficult and a time-consuming. Using experienced and reliable experts in each area can greatly reduce the overall cost for you and take a lot of stress out of often high-pressure property transactions.

An application that is correctly packaged and well-presented upfront, although time-consuming, can save significant time and expense in the future. From securing the best possible terms, to ensuring the application and legal process are handled in a timely fashion, working with experts can save you significant time and money.

For more information on property development finance, head over to our development finance product page. Alternatively, enquire online or speak to an advisor on 01922 620008.

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All types of development
including barn conversions

Finance for land only
with or without planning

All enquiries considered
from £25,000 to £100 million

Large developments accepted
also single properties