An introduction to development finance
What is development finance?
Development finance is a type of lending used to pay for the construction, conversion or refurbishment of property. This type of loan, from £100k upwards, can be used to develop one single building, several properties or a multi-site development.
A short-term finance product typically taken over 12-18 months but occasionally up to three years, development finance is used to cover the construction or refurbishment only and is repaid once the project is complete, usually through the sale or rental of the property.
Fees include upfront and exit costs, plus monthly interest charged on the total amount borrowed – these are calculated at each stage, so less after an initial stage payment, but more at the final stage, prior to completion. As a short-term product, costs may appear higher than a traditional mortgage but – like the bricks used on site – development finance should be considered as a project cost.
Working with Complete Commercial Finance, a developer can find the right development finance at the right cost to suit their unique needs. Working with a broker can reduce the time it takes to secure funding and eliminate the need to ‘shop around’.
How does development finance work?
Development finance is provided in two parts with an initial payment – usually 65-70 per cent of the purchase value, less any charges and interest – to fund the acquisition of a site.
Funds to develop the project – up to 100 per cent of the building and refurbishment costs, as required – are subsequently released in staged payments, with each made after the lender is satisfied there is sufficient value in the project and funds are being used appropriately at each step.
A monitoring surveyor will visit at agreed stages to ensure the development is on track and advise the lender on progress. Ensuring the development runs in tandem with these inspections is key to ensuring there are no cashflow issues which may impact your supplies, team and reputation.
Costing and scheduling, both at the outset and throughout the build will be enormously important to achieving a successful project. For example, in autumn a project needs to be watertight before winter weather sets in, and in spring it’s key to hit the start of the buying season and tax year. If an issue does arise, it is best to speak with your commercial finance broker or lender as early as possible to create a solution before costs escalate and profit is eroded.
How can I apply for development finance?
All lenders will follow a similar process and want to see key documents before committing funds to a property development.
If a project requires planning permission they will require details or to see an application on a local authority’s planning portal. They will want to see the detail of the plan’s drawings and a detailed breakdown of costs to sense-check your figures.
Every lender will want an asset, liability, income and expenditure (ALIE) summary which shows how resilient you and the project are to unexpected delays or costs, and many will want to know you can provide 20 per cent of the loan with a personal guarantee.
Broadly speaking, the gross development value (GDV) of a project should be at least 20 per cent higher than the total costs, and external estate agents’ valuations may be helpful in supporting your proposal.
Demonstrating your capability, a development CV, even if you are embarking on your first project will strengthen your case for lending, as will outlining the team you plan to work with – in some cases, their credentials may support your application. A schedule, broken down by stage including a proposed ‘exit strategy’ upon completion, will help identify payments and the terms of your borrowing agreement.
How can I become a property developer with no deposit?
A deposit can come in the form of land, cash or other assets. As with many other sectors, join venture finance – or 100 per cent development finance – means that a lender is willing to back a project where a developer has no deposit, in exchange for a share of the profits at the end of the project. The lender will still charge interest on the amount borrowed in addition to up to 50 per cent of the profit. Alternatively, a private investor may choose to work with a developer using a Special Purpose Vehicle (SPV) limited company with similar terms in place.
What are the different types of property development?
There are many types of property development, but here are some common scenarios:
• ‘Flipping’ is a term used to describe a quick transaction when a property is purchased at a low rate and sold on for profit. Auction properties often have the potential to be ‘flipped;’ but be careful to undertake thorough research and due diligence for potential issues before committing to a purchase. Additionally, by building strong connections with local estate agents and landowners you may be able to identify opportunities before a property or site comes to market.
• Refurbishment is still a profitable way to undertake a development with strong return on investment. Alongside modernising a property to improve its marketability (light refurbishment), an extension or loft conversion can enhance the value of a property (heavy refurbishment). Again, be careful to ensure that your improvements will gain planning permission, if required, and that there will be no objections to your development. Lenders will want to know the stage of planning permission before supporting an application for funds.
• Property conversion can offer greater returns on investment than the previous types of property development, and there are many scenarios where converting a building will increase its purchase value. Whether it is adapting a house into flats or a HMO, or converting a commercial premises to a residential space, there are many opportunities but it is vital that you undertake professional advice on the viability of a plan and the likelihood of gaining planning permission.
• Ground up developments require a site purchase followed by the construction of a property or properties. Although the most cost-heavy way to undertake property development and requiring knowledge and expertise, a ground up development will require full planning permission and often yield a strong return on investment.
How do I become a first-time property developer?
Many homeowners who have enjoyed developing their own property and had success in increasing the value of their home through improvements are often drawn to the idea of becoming a property developer.
However, it is important to understand that property development is a business, not a pastime, and as anyone who has successfully made the leap to become a developer will atest, it is crucial to fully scope the time, resources and costs involved in a development, alongside the likely profit that can be made – incorporating a margin for unforeseen variables, a project must add up to be truly profitable.
This is important, not just from a personal need to generate an income, but also to improve your chances of securing development funding from a bank or alternative lender. Many traditional lenders will be unwilling to fund a first-time developer and want to see several completed projects before they are willing to risk lending on a future project.
However, a multitude of alternative and specialist lenders are willing to fund a first-time developer without a portfolio – they understand and will work closely with you to ensure that your development is viable, stays on track and completes in line with your project plan.
A phrase you will often hear is, ‘What are the numbers?’ and these must stack up. Be cautious about over-extending yourself when considering a site or property – estate agents represent the vendor and projects with development potential can escalate into a scenario of closed bids. Be careful not to exceed your best offer or you will be eroding profit before you have even broken ground, and it is better to be upfront with an estate agent and walk away without damaging your reputation with a failed project later on.
Working with a trusted and reliable team – from your commercial finance broker to your construction crew – is essential in delivering a high standard project which meets market demands. Again, talk with a trusted estate agent about the potential to market your development and to establish a realistic revenue figure for your project. Plan your project timeline, with a realistic and costed schedule that allows for services to be installed – if there are delays or a long lead time on having utilities installed, this will ultimately cost you profit if you have not calculated and scheduled these as part of your plan. Again, a lender will want to see that you have considered and factored in these potential issues.
Why should I use a broker to secure development finance?
Organising finance is a major aspect of a successful development project and it makes absolute sense to ensure that you maximise your chances of securing funding from a supportive lender and at the best rate available. There are many specialist lenders who are able to support first-time developers and it may be useful to work with a broker to identify the best match for your project. Although experienced developers may feel confident in organising finance themselves, it will take time and requires careful attention to ensure this is in place, particularly with several plans in play, and this may be time better spent focusing on ensuring a project runs smoothly.
