What is property development finance?
Property development finance is used to fund the development or conversion of buildings. The loans are usually set up as a short-term loan, only to be used during the build, with the loan repaid once works are completed. The repayment of these loans are most commonly made through the sale of the property, or refinance onto more suitable long-term debt, such as a mortgage.
How does it work?
Development finance is usually secured against the property, or development site, much like a residential mortgage is secured over a house. Unlike a mortgage, property development loans are usually drawn down in stages, as the project progresses.
Initially, an advance is made against the value of the site, this can either be used to purchase the site, repay any outstanding loans that are secured against the site, or to begin construction. Lenders are usually happy to advance around 65% on day 1.
Throughout the build, at agreed stages in the build, progress is checked by a monitoring surveyor and as long as everything is on track, further funds are released. This process is then repeated until works are complete and the loan is ready to be repaid.
When borrowing 65% on day 1, lenders are often happy to advance as much as 100% of the build costs. This will depend on the amount owing against the total value of the site during the build.
Do I have to make monthly payments?
No, the monthly payments are usually deducted from any advances, meaning the interest is effectively added into the loan. This works in the same way as most bridging loans and is particularly useful during development projects as cash flow can be difficult to manage.
Development finance rates and charges
The rates charged will depend on a number of factors. The main ones are:-
- The developer’s profile – Property development finance applications are largely priced based on the risk presented. Highly experienced developers will usually attract much lower interest rates as they have a strong track record of successful development.
- The project being undertaken – The type of scheme being undertaken can also affect pricing. Lenders will tend to favour loans with a higher gross development value (the end value of the scheme) over very small schemes. Where the project is similar to previous developments that have been successfully completed by the applicant, this will be likely to reduce the rate charged.
- Location – Some lenders will only lend in certain locations whilst others may avoid certain locations. As such, this can affect pricing as rates vary from lender to lender.
- The loan amount required – If your loan amount is too low, you may find that the rate charged is higher. Small loans require just as much work to arrange as larger loans, and as such, the lender will have to charge more to ensure that it is still profitable for them. Economies of scale are heavily at play in almost all areas of property development.
The pros and cons of taking out development finance
There are a number of advantages and disadvantages in financing your property development project. It’s common for developers who would be able to fund a development without finance to borrow against a scheme.
Of course, each development is different and it’s important that you weigh up the pros and cons before taking out finance. Some of the major arguments for and against taking out a property development loan can be found below.
- Development finance allows you to take on much larger projects than would otherwise be possible. – By financing your developments, you will open yourself up to much bigger projects, which means much bigger potential profits.
- You retain your capital and could potentially use it elsewhere to profit further – You could potentially look to take on 2-3 financed developments, rather than 1 which is funded in cash. This could potentially produce far greater profits and splits your risk between all sites, rather than being totally reliant on 1 project.
- Your return on investment will be greatly increased – You can reduce the cash outlay required dramatically and the cost of finance will only have a small effect on the total profit. This means the profit made per £ spent is far higher.
- You are risking less of your own money – Of course, nobody goes into a development project expecting it to fail, but you must consider all outcomes. In the event of the development failing, you will be limiting your cash exposure if the scheme is financed.
- Your cash flow may be greatly improved – Developers tend to be asset rich, with poor cash flow. You can negate this using property development finance and to leave you with larger cash reserves during the build.
- The application process is not simple – Development finance lenders require a lot of information and will often require face to face meetings on site. This can be daunting for some people. Although the application process can be tricky, a good broker will be able to take a lot of the stress out of it.
- The lender will want to visit the site throughout the build – In order to approve the staged drawdowns, the lender will need to send their monitoring surveyor out to visit the property throughout the build. This can be a difficult to fit in easily as the actual development tends to take up a lot of your time.