Gary Hemming, ABC Finance Ltd
Property development is a highly profitable industry and property development finance can be used to allow you to take on larger schemes without breaking the bank.
Read on to find out more about development finance, including what it is, how much it costs and a breakdown of some really useful pros and cons.
What is property development finance?
Unlike mortgages, property development loans are short-term and generally used only to fund the build, or conversion or property. At the end of the build, or term of the loan, the properties are usually either sold, refinanced to a cheaper development exit product or longer-term loan. Most development finance lenders will fund a percentage of the site purchase as long as the relevant planning is in place. If not, there are pre-planning products available that allow you to purchase and gain planning.
The risk posed to the lender is greater during the construction phase and the security more difficult to sell in the event of default. As a result, the interest rates charged are usually far higher than mortgages, meaning they aren’t a viable option long-term.
How much does development finance cost?
Property development finance costs can vary from lender to lender. The amount charged is generally from around 5% per annum, right up to 16.2% p.a.
The interest rate charged depends on the perceived risk of the application. The lender will usually look at the site location, clients experience in similar projects, loan size and the overall loan to GDV (end value).
On top of the interest charged, there may be other fees to consider.
Most lenders charge an arrangement fee for setting up the loan, this is usually 1-2% of the total facility amount.
In addition, some lenders will also charge a redemption fee when the loan is redeemed. This loan is again usually 1-2%, usually of the loan amount, but is sometimes charged on the gross development value.
When using a broker, they will often take their payment directly from the lender. Sometimes a broker fee will be charged, either because the most suitable lender does not pay them, or just because that is the brokers charging structure. Where a broker fee is due, expect to pay 1-1.5%, with the fee usually added to the loan.
How much can I borrow?
The level of funding offered is generally restricted by the value of the security, both the value on day one and the gross development value.
To manage the loan to value throughout the build, the loan is usually released in stages at regular intervals. The stage released payments are usually either broken down by monthly releases or against set benchmarks on the build.
When initially drawing down your loan, most lenders are happy to lend up to 65-70% of the day one value or purchase price. In addition, some lenders will release the full build costs, subject to the overall loan to GDV (the ratio of the loan vs the final scheme value).
To ensure the stage released payments are managed correctly, and that the project remains on track, a monitoring surveyor is usually appointed. Their job is to check the progress of the build, the quality of works and the ongoing value of the site.
It is usually possible to borrow up to 70% of the gross development value as a total facility, although the cheapest products are usually capped at 55-60%.
How do lenders assess development finance applications?
Each lender has their own methods of assessing applications, although there is a large crossover in the information requested by them. Generally, expect to have to provide the following information:-
- Personal details – such as the name, date of birth, address of yourself/the directors of the company (where purchased through an Ltd company).
- The details of any planning permission – including any planned revisions or future applications.
- Detailed costings and timescales for the scheme – usually the lender will expect this to be broken down by both month and what the money will be spent on.
- Details of your professional advisors – such as architects, accountants, solicitors and contractors.
- An up to date development CV for all borrowers – This should give detail on previous schemes undertaken.
Do I have to make monthly payments?
The monthly interest is usually added to the loan, meaning there is nothing to pay on a monthly basis. Although the interest could be paid monthly in theory, adding it to the loan is considered simpler as developments tend to have poor cash flow, with all the money coming in at the end of the project.
Are there any drawbacks to taking out a property development loan?
Yes, by taking out a property development loan, you will have to answer to the lender throughout the build. To release the next stage payment, you will have to arrange site visits, remain in communication with the lender and provide updates on the build. Although this isn’t too onerous, it is another thing to manage during an already busy time.
The second drawback of taking out property development finance is that lenders require a lot of information to assess an application. Although this can be tricky, the reality is that if the project is well planned, most of the information required will already be available.
Thirdly, obviously using finance will incur fees and interest which will cut into your overall profit.
Why is property development finance so popular?
Property development loans can create potentially large profits for property developers, by opening up the possibility of taking on larger schemes. Even where a project could be funded without finance, by putting less money into the scheme you may be able to fund multiple projects.
Also, property development can create large profits for the developer, but requires a long period of outlay, with the profit coming at the end. This can cause cash flow to be poor during the build, something that can be resolved by financing the site.