Development finance explained
What is development finance?
Property development finance is a type of funding used to finance the construction, conversion or heavy refurbishment of buildings. The loan is usually set up as a short-term loan to fund the project only during the build.
Once the project has been built out, the loan is usually repaid through the sale of the property, or refinance to a residential, or buy to let mortgage.
The terms ‘development finance’, ‘property development finance’ and ‘property development loans’ are used interchangeably and all represent the same type of borrowing.
What are the benefits of property development finance?
Take on larger projects – By taking out this type of loan, you can put far less money into a project. It’s not uncommon to only put in 10% of the cost of the project, borrowing 90% loan to cost. This means your savings don’t have to all be put into the project. This has two benefits:
You can use those funds elsewhere as other opportunities arise.
You are far less committed to the project financially. Generally, it’s never considered to be a good thing when all your eggs are in one basket, so diversification is key. Protect your savings by financing your developments.
Increase your return on investment – Property development increases your return on investment. By putting far less money into the project and only reducing the profit a small amount, you will be getting a far greater return per £ invested.
Leveraging business transactions has long been used to get the best possible return on investment and it’s no different here. You can make your money work much harder for you by taking out property development funding.
An example of property development finance in practice
A client is buying a site for £1,000,000 and is looking to build out into 12×3 bedroom homes.
The build would cost £1,800,000 and it is expected to sell for £4,600,000. The client is an experienced developer with a strong net worth. They plan to sell the finished houses on the open market.
|Gross Development Value||£4,600,000|
The client needs to borrow both to fund the purchase, and would like to finance the full build costs, if possible. We can lend 70% of the purchase of the site and 100% of the build costs with our chosen lender, if the total borrowing is less than 90% of the total cost of the project.
|Day 1 Value||£1,000,000|
|70% of Day 1 Value||£700,000|
By lending 70% of the purchase price and 100% of the build costs, the client can borrow £2,500,000. This figure is just under 90% of the total project costs.
|Total Project Cost||£2,800,000|
|90% Of Total Project Cost||£2,520,000|
The £700,000 required to complete the purchase would be released upfront, with the remaining funds released over the term of the loan.
The final step is to ensure the funds borrowed fit the lender’s loan to gross development value (GDV) calculation. In this example, the client can borrow up to 75% of the gross development value.
|Gross Development Value||£4,600,000|
|Loan to GDV||54.3%|
In this situation, the loan would fit the lender’s criteria and we would be able to move forward with the application.
How does development finance work?
The funds release process explained
Funds are usually released in stages, with the initial release usually used to purchase the site, or refinance any existing debt on there (where it is already owned).
Once the site is secured and the initial funds have been issued, the rest of the funds are released in stages to pay for the construction. On each release, the lender will check your progress against what you told them during the application process. To avoid issues, you should work as closely to your schedule of works as possible and inform the lender as soon as possible when you deviate from it.
How long does it take?
Completion of your application is usually achieved in around 6 weeks. If you need the application to be wrapped up particularly quickly, inform your adviser upfront. If your deadline is particularly tight, we will mark your application as urgent to ensure you can draw down your funds in time.
When should I apply?
This type of finance is usually only usually available for sites with full planning permission. If you want to borrow before you have planning, you should consider planning gain finance.
You should submit your application early to allow for any delays. This can be complex, and delays can occur where new information comes to light. Our advisers can arrange your application while you wait for planning permission.
Do I have to pay the interest during the loan term?
Although some lenders do expect you to make payments during the term of the loan, this is rare. Most lenders allow you to roll-up the interest during the loan term.
The interest is then paid when the loan is repaid.
Some lenders will allow you to pay the interest charges monthly, however this is far from common and can complicate things. The lender would need to see proof of income to support this and in practice it’s often difficult to meet the payments as cash flow is often stretched during construction.
Types of property development finance
What are the different types of property development finance?
The most suitable product depends on the type of scheme you’re planning, and the level of works involved.
Ground up builds – These projects always require property development finance. Once built, development exit finance may become a cheaper alternative, but can’t be used before the scheme is wind and watertight.
Property conversions & large scale restorations – These schemes are usually funded using property refurbishment finance, although development finance can be used for very large, or complex schemes.
Property refurbishment – Here, property refurbishment finance would be the most suitable option. These loans are a type of bridging loan and allow you to undertake anything from light refurbishment, right up to extensions, structural changes and reroofing a property.
I’m looking to buy properties and improve them before selling, can I get property development finance?
We can fund these schemes for you, although for these types of project, bridging finance is usually a more suitable option.
We can fund a proportion of the purchase price and usually the full cost of works, where required.
How do property development loans differ from a bridging loan?
There is a big crossover between property development loans and bridging loans, especially when looking at funding a site through planning, before building it out or refurbishing the property.
The key factor is how heavy the work involved is going to be. If there is a significant extension (40% of the floor space or more) then you are likely to need a property development loan. Ground up development will always require property a bespoke property development product, and conversions with no extension may qualify for either product.
How much can I borrow?
How is the maximum loan calculated?
The maximum borrowing is usually based around three main points:
Day one advance: This is the amount that the lender is happy to advance at the start of the loan. This figure is usually limited to 65-70% of the property value, although some lenders do not limit this figure at all.
Loan to cost: This is how much the lender is happy to advance as a percentage of the total project cost. This figure is usually between 80-90% of the total project cost.
Loan to GDV: This is the lenders maximum loan as a percentage of the final project value. Most lenders will offer between 60-70% of the gross development value (GDV).
How are the stage releases agreed?
The stages are agreed between yourself and the lender based on your schedule of works and costs. This will lead to natural points at which funding is needed to allow you to successfully manage your cash flow.
Each project will run differently and as such, funding will generally be based on what allows you to complete your project as quickly and efficiently as possible.
In terms of the maximum amount released by stage, some lenders restrict funding to a percentage of the current value, as stated by a monitoring surveyor. This method is commonly used for smaller schemes.
For larger schemes, the lender will usually ignore the current value, focussing solely on the GDV and your success in sticking to the build programme. This method is checked by a QS (quantity surveyor) and removes the risk of the property valuing at less than expected during the build, therefore starving the scheme of cash flow.
Costs of development finance
These loans tend to come with a number of fees due to their complexity. The biggest costs can be broken down into 2 parts – interest and fees:
The interest charged by the lender is usually the biggest cost associated with the facility. Rates start at 4.5%, but rates of 6.5-9% are far more common. The lowest rates are usually associated with the lowest risk applications. This means ones with a solid contribution from the developer, along with a very strong track record.
Although interest tends to be the largest cost, simply choosing the lowest rate isn’t always the best option. The total cost of the facility must be taken into account and consideration must be given to all fees. Sometimes a very low rate product will work out more expensive than another product with a higher rate, but more favourable fees.
Arrangement/facility fee – This fee is charged by the lender for arranging the facility and is usually between 1-3% of the loan amount. This is usually added to the loan and repaid at the end of the term. This fee can be based on the gross loan (the amount including all rolled-up fees and interest) or the net loan (the amount released to you), depending on the lender chosen.
Broker fees – Some brokers charge a fee for using their service, which can be up to 2% of the loan amount, usually charged as a ‘success fee’ on completion of the loan.
We expect to earn 1% on a property development application, which is often paid to us as a commission by the lender. Where we are not being paid by the lender, we will charge a separate broker fee, which we will disclose upfront, although we always try to avoid doing so.
If your application does not progress to completion, we wouldn’t charge you any fees.
Exit fees – Exit fees are often charged, usually as a percentage of either the loan amount or gross development value. This is usually paid off at the very end of the loan when you refinance or sell the completed development.
Non-utilisation fees – Non-utilisation fees are interest or charges levied against the portion of the facility that has been agreed but has not yet been borrowed. They effectively allow the lender to charge you for funds that you are yet to borrow.
Valuation fees – This is charged to appoint a RICS surveyor to undertake a survey and valuation on the site. This will cover the current value of the site along with the value when complete (known as the gross development value).
In addition, commentary will generally be provided around demand for the finished properties on market and likely marketing periods required to achieve sales reliably.
This fee is usually paid early in the application process and is only required once. Should there be an issue after the surveyor has visited, this is generally not refundable.
QS fees – In order to keep track of the build while it is ongoing, the lender will appoint a quantity surveyor or monitoring surveyor. They will provide commentary around your development costings and schedule of works. Once these have been agreed, this will become the basis for your drawdown schedule.
Throughout the build, the QS or monitoring surveyor will then visit the site periodically to ensure that the build is on track. Each time another visit is undertaken, a further fee is usually added to the loan to cover the cost.
Legal fees – These are charged by your chosen solicitor to manage the process of legally completing the loan. The lenders legal fees are also usually charged to the borrower. The cost of which must be met.
Drawdown fees – Each time a drawdown is taken, fees may become payable. As a minimum, telegraphic transfer (TT) fees are usually charged each time funds are released.
Other admin & banking fees – The other fees charged will generally be small in comparison but can add up. Sometimes admin fees will be charged by the lender or broker. This is something we never do.
Can you get 100% development finance?
Yes, 100% funding can be offered in 2 ways. The first is through joint venture funding, which usually involves borrowing all of the project costs and then sharing the profit with the lender once complete.
The second way is achieved by providing additional security by way of another property or land that can act as your deposit. The property used can be your own home, or an investment property.
Where to get property development loans
Who offers property development finance?
There are different types of lenders in the market, and each have their own advantages and disadvantages. The main types are the following:
High street banks – These lenders are the well-known banks that you see on the high street. They tend to take a very cautious approach when lending to property developers and will only lend to very experienced developers and usually require a large deposit. The payoff for working with a high street bank is access to very low interest rates.
Challenger banks – A group of lenders who take slightly higher risks than their high street counterparts, challenger banks are crucial for the market. They offer lending with smaller deposits and may lend in secondary locations. You’ll pay a slightly higher rate than on the high street, but will have a simpler application process and less onerous criteria.
Specialist property development finance lenders – There are a number of specialist development finance lenders, and they range in their approach to lending. Each lender usually has their own niche, whether that’s very low rates, higher gearing, flexible criteria or very fast service. The market can be tricky to navigate, so research is key.
Short-term lenders – Many bridging loan lenders offer property development finance. They’re likely to offer very simple underwriting and fast service, but usually charge higher interest rates.
Working directly with a lender or through a broker
A broker’s job is to help to match you with the most suitable lender for your circumstances. It’s important that you work with an experienced broker, as property development loans are complex.
As this type of borrowing works in a very specialist way, an experienced broker will help you to navigate through the application process and can save you time and hassle. An inexperienced broker will simply add another layer to an already complex situation, so research is key.
We’ve been arranging property development finance for over 20 years.
Development finance criteria
Who can apply?
We can offer funding for the following:
- SPV limited companies
- Trading businesses
- Overseas investors planning a UK development
Does planning permission have to be in place?
Planning does not need to be in place at the time of application, but you will not usually be able to complete until it is. This is because most lenders operate a strict mobility period. This is usually one month, before works must begin on the project. This would clearly not be possible if planning was not in place.
In addition, planning approval can never be guaranteed, meaning that funding for the build and timescales can’t be reliably agreed at that point.
Where you’re looking to fund your scheme through the planning process, planning gain finance is usually the most suitable product for you.
Can funding be arranged for first time developers?
Yes, we often arrange funding for first-time developers. Although many lenders look to work only with experienced borrowers, there are still some solid options out there for those looking to get into property development for the first time.
Where funding is required by a first-time developer, the experience of the team around you becomes highly important and will be closely scrutinised.
For those looking for 100% development finance, we can only offer funding to experienced developers.
Can you arrange funding for people with adverse credit?
Yes, we can fund applications from borrowers with a history of missed payments, defaults, CCJs, settled IVAs and even historic bankruptcies.
We have successfully arranged funding for developers with previously failed developments.
In these situations, the lender will want any previous adverse credit or failed schemes to be explained. Your chances of success will be greatly improved by producing a write up on any previous issues and providing it upfront to the lender.
This will give them greater confidence that you’ve faced the issue and are less likely to find yourself back in the same position in the future.
Can you fund projects under Permitted Development Rights (PDR)?
Yes, funding for conversion schemes can be funded without issue. Permitted development schemes are very popular, and can be highly profitable. As such, there are many lenders who are keen to work on these projects.
We can fund these schemes for both experienced and inexperienced applicants.
Depending on the level of works involved, you may save money by funding the scheme using heavy refurbishment finance.
Should you choose to work with us, we compare both options for you, looking at any opportunity to save you money.
Can finance be arranged for part-built schemes?
This is a surprisingly tricky area of the market; lenders are generally very cautious about taking on part-built projects. This is because they have had no sight of the scheme during the build and have no monitoring reports to check the quality of work done.
Where one lender is being repaid and another taking over, this may be easier to fund as the new lender can see the monitoring surveyor or QS reports. Where no lender is in place, the new lender will want to ensure that as much information about the build up to this point as possible is available.
Although these schemes are more difficult to fund, we do regularly fund them and should be able to help.
Will I qualify?
There are hundreds of different property development loans out there and they cover almost all the property development arena.
There are specialist development funding lenders in the market who are willing to lend to inexperienced developers, people without a deposit and on difficult sites. Whatever your circumstances, we will usually have a lender for you.
The key factors in the success of a property development loan application are that the site is profitable, the build is realistic and that there is demand for the finished product.
Of course, if you aren’t looking to take on joint-venture finance, the ability to fund the deposit will also be a major factor in the lending decision.
Is property development profitable?
Property development can be a very profitable industry, although it can’t be considered easy, or risk free – especially for first time developers. Building a property is very complex and there’s lots of things that can go wrong, so be prepared for a steep learning curve.
Given time, many property developers learn how to avoid, or manage these issues and their schemes become more profitable.
Managed well, property development can be extremely profitable.
How do I get started in property development?
Most developers start small, either through refurbishing and selling property for a profit, or converting property where profitable. The key when starting out is research – read, watch videos, attend courses and seek out advice from experts.
How is development finance repaid?
Repayment of the loan generally happens after the completion of the properties. Although this is the case, some funders will consider refinance to development exit finance as soon as the properties are wind and watertight. This may allow you to save money.
Schemes are usually repaid through one of three main routes:
Sale of the properties – the properties are sold, and the loan is repaid as sales complete. In most cases, 100% of the sales proceeds are assigned to repay the loan, with your funds coming once the lender has been repaid.
Refinance to development exit finance – As mentioned above, these loans can be used to fund the final stages of the build, or the sales period. Refinance to development exit finance is usually done to either secure a lower rate or to release capital from the project. This enables you to move onto the next scheme. In addition to this, this type of funder may allow you to keep a proportion of the sales proceeds, which can really help cash flow.
Refinance to a buy to let or commercial mortgage – Where the properties are to be retained, refinance to longer term debt is usually the most suitable exit strategy.
Sometimes a combination of these methods is used, allowing the developer to sell some units on completion and refinance others. This is common where some properties are to be retained and let, or off plan sales were already agreed for some units.
What are the main things I should consider before applying?
It costs money – Although property development loans increase your return on investment, they also cost money. This will reduce the overall profit of your scheme as the finance will be an added expense. This can of course be offset by taking on larger, or multiple projects. But on a project by project basis, financed developments will make slightly less money.
Your lender will want to visit the site – The lender will want to visit the site throughout the build before releasing each stage payment to you. Whether it is a representative of the lender, or a quantity surveyor, you will have to set aside time when you want to draw down money to show somebody your work. Although it doesn’t take up too much time, it is another commitment and must be considered.
You will have to provide all of the required information needed to apply – The documents needed to submit your application can be time consuming to produce. The lender will want to see the planning permission details, drawings, costings, details of your track record and will need an application form to be completed.