The decision to finance a property development can have a profound effect on the financial outcome of a scheme. There are two main factors in the decision to raise finance against your property developments.
Property development is all about return on investment. How much profit you can make, and how much you need to spend in order to realise it.
In this guide, we will break down what return on investment (ROI) is, how finance ties in with the expected ROI of a scheme and real-life examples of the impact of development finance on ROI.
What is ROI?
It is the ratio of the income received compared to the amount of money spent to facilitate a transaction.
ROI is considered to be a strong metric in determining the efficiency of an investment.
How does ROI impact property development?
By using finance, you’re able to deploy less capital and the key here is what benefit can be derived from that.
It may be that you’re able to use the remainder of your funds profitably elsewhere, that you can look at larger projects or that it’s easier to secure external investment in your project.
We will break each factor down below.
The size of project that you can take on
The project size is greatly increased when development finance is taken out. The deposit required for property developments are generally quite low, with funding available up to 77.5% of the GDV, and up to 70% of the purchase price.
Extremely profitable deals that were previously too large to consider can be comfortably funded with development finance.
Related – Read our guide to getting into property development.
The number of projects that can be taken on
If you’re funding your own property developments without finance, you must put 100% of the money into the deal. The cash needed to complete the project must be set aside from the start and can’t be accessed until the project is sold. Where a large percentage of your total funds are input into a scheme, this can affect your ability to look at other projects.
Although this may not be a massive issue while the construction is flat out and time may not be on your side, it can be very frustrating as the project is ending. When you’re waiting for building regulations sign off, or for sales to come through and looking for your next project, opportunities may come thick and fast.
Property development is a competitive industry and the best schemes will always be time critical. If you’re competing with cash buyers, you must be able to act quickly. This is only possible if liquid funds are available.
Improving your return on investment (ROI)
By putting less money into a project and financing the rest, the ROI produced is improved dramatically. Below are two examples of recent projects we have worked on to show the difference in ROI between running the project using finance or without.
Kingston Upon Thames
By choosing to finance a scheme in Kingston upon Thames, a client of ours was able to increase their projected return on investment from 56.4% to 249.41%!
Although the overall profit was slightly lower, this was more than offset by the reduced capital outlay. By reducing the cash needed to fund the scheme, the client retained the ability to react to other schemes hitting the market quickly. This opened the door to further profit.
The detailed numbers can be found below:
|Total Purchase & Development Cost||£ 3,248,652.00||£ 3,248,652.00|
|GDV||£ 5,080,000.00||£ 5,080,000.00|
|Total Cash Input||£ 3,248,652.00||£ 650,465.00|
|Total Finance Amount||£ –||£ 2,598,187.00|
|Total Finance Costs||£ –||£ 209,011.00|
|Profit||£ 1,831,348.00||£ 1,622,337.00|
We received a proposal for an excellent scheme in Dorking, which the client was considering financing. The client found themselves in a similar position to the above, except the total cost of the scheme was £7,359,500.
This is a lot of money to commit for a 12-month project and although the figures were strong, the unfinanced ROI of 31.8% was almost 4x lower than the financed ROI – 126%.
|Total Purchase & Development Cost||£ 7,359,500.00||£ 7,359,500.00|
|GDV||£ 9,700,000.00||£ 9,700,000.00|
|Total Cash Input||£ 7,359,500.00||£ 1,400,000.00|
|Total Finance Amount||£ –||£ 6,098,000.00|
|Total Finance Costs||£ –||£ 582,790.00|
|Profit||£ 2,340,500.00||£ 1,757,710.00|