An introduction to property development finance
Property development finance is a type of short-term loan used for new builds, part-builds or property refurbishment schemes. For these types of projects a commercial mortgage is not an option since the properties are un-mortgageable. Therefore, property developers use development finance to give them the capital they require to complete these types of schemes.
There are many types of development finance available, but from a lender’s perspective, they fall into three major categories:
A light refurbishment typically involves purchasing an existing building and then doing a range of small repairs and improvements. Renovations might include upgrading a kitchen and/or bathroom, minor room layout changes and redecoration. To be classed as light refurbishment the total cost of the improvements should not exceed 15 to 20% of the original purchase price of the property. Also, the alterations should not require planning consent and lenders expect a light refurbishment to be complete within three months.
A heavy refurbishment involves buying an existing building that requires structural work and will, therefore, need planning consent. Because the project usually requires far more work, the cost will likely be more than 20% of the original purchase price of the property. In this case, lenders would expect the process to take between three and six months to complete.
Ground-up is where a developer acquires land, usually with planning permission and then constructs one or more new properties on the site. Alternatively, the developer purchases land with existing buildings, demolishes the buildings and erects new ones in their place. Ground-up developments are by far the most complex category as more significant planning, and a team of builders, architects and other trades are required. Finance will need to be in place for many months or years and projects will often require more than one type of loan to complete to sale.
What types of funding are available?
It is useful to establish, as quickly as possible, the category of development you are dealing with as this will determine the nature of funding required. The type of loan needed will then indicate which lenders will be interested and what interest rates and terms they will offer to the developer. This additional information will then allow the developer to budget for the finance cost of the project which in turn helps confirm the potential profitability of the project.
Property auctions are an increasingly common source of properties suitable for refurbishment. An auction can be a quick and sometimes cheap way of buying a property. However, auction houses typically require payment within 28 days, which means you have to move fast to finance your purchase. Auction finance lenders deliver money quickly, but as always in finance quick often means expensive. Similarly, some lenders will prearrange a loan facility for you so that you can arrive at the auction prepared and not risk losing your deposit due to non-payment of your purchase.
There is a wide range of financial products available to fund property projects. For light or heavy refurbishment projects, short-term bridging loans are often used while for more extensive projects and also ground-up projects development finance is ideal. There are many more types of specialist finance such as refurbishment to term, marketing bridges, mezzanine finance the list goes on. Which is why the services of a finance broker can be so helpful to a busy developer as the broker can help navigate the complex range of funding options available.
How much can I borrow?
Funds are still available for good quality development projects, and if your project meets lender’s criteria, we can help you source development loans from £50k up to £20+ million.
Most lenders will require the developer to contribute a deposit. The lender will then provide the balance of the funds needed in the form of the loan.
All borrowers need to be solvent and have an acceptable credit profile. If there are historical credit issues, then convincing reasons need to be given to explain away any past problems such as missed loan repayments or CCJ’s. Lenders should always be made aware of any potential issues from the start of the loan application as nothing will sour a deal quicker than a lender thinking facts are being hidden from them.
Most lenders will insist on personal guarantees from borrowers. To help with this, Fusion Finance can source personal guarantee insurance that covers against this risk in the case of a default.
How does property development finance work?
In most cases, the developer will finance the land acquisition cost while the lender will provide some or all of the remaining build costs. Funding is usually released in stages as the build progresses. Staged payments are then made by the lender at regular, pre-agreed intervals to cover the costs of the ongoing building work. A monitoring surveyor will need to confirm that all the scheduled works are completed to the correct standards before the funds are released.
What are the standard terms of this type of loan?
Depending on the size and type of project most property development loans operate for between 6 to 24 months. They are typically interest-only with the interest rolled up into the loan. This means that there are no scheduled repayments made by the borrower during the term of the loan. These loans can then be exited by the sale of the property, a marketing bridge or a term loan.
How much interest can I expect to pay?
Many factors affect the interest rate charged by a lender. Two of the major ones are the developer’s financial contribution to the project and their previous development experience. The more experience the borrower has and the more they contribute to the deal, the lower the rate of interest they will be charged by the lender. There are of course many more factors that affect the rate charged which is why these types of loans are always dealt with on a case by case basis.
What about fees and other costs.
Lender fees for development lending tend to include ‘arrangement fees’ and often ‘exit fees’. These charges vary but are typically between 2% to 4% of the overall loan facility.
The developer will have to budget for other costs including the legal fees for both parties, the initial valuation and quantity surveyor appraisal of the scheme and expenses associated with the interim monitoring surveyor that the lender appoints.
Will a lender support me?
Lenders prefer to support experienced builders and developers who have a history of successfully delivering development schemes on time and on budget. However, first-time developers can also find support if they show that they have a well-experienced team around them, e.g. project manager, architect, quantity surveyor, seasoned contractors etc.
Lenders also want to see that the developer has budgeted for all the likely costs of the project, researched the selling price of the properties, and calculated the prospective profit margins, to ensure that the scheme is viable with a strong prospect of success.
What paperwork will I need?
When approaching a lender, a developer will need to provide lots of information including but not limited to the following:
- Value of the land/property in the form of a professional valuation report
- Total build costs of construction/refurbishment including a contingency
- Details of the other professionals involved in the project, builders, planner, architect etc.
- A timetable for the development
- A portfolio or CV of previous experience with development projects
- A copy of any necessary planning permissions
- Any planning restrictions that might apply to the project
- Details of building regulations
- The anticipated final value of the project, gross developed value (GDV), along with evidence of how this value is calculated
Property development can be a complex subject, and all successful property developers need a good plan. Getting the right finance in place is a crucial part of that plan and is essential to ensure the success of any project. The availability of funds for property development projects continues to grow and strengthen. Fusion Finance has access to about 40 specialist property funders across the lender spectrum, lenders that are all actively looking to support good quality property development projects.
How do I apply?
Fusion Finance can help with all types of property development finance, we can source funding for a wide range of property developments, from low-end projects requiring less than £100K of funding to schemes requiring £20 million or more.
So if you require any additional information or are ready to move ahead with a development project, then please get in touch.
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