Development Finance in a Nutshell

Types of Development Finance

• Residential property development
• Commercial / Semi Commercial property development
• Renovations / conversions/ refurbishment
• New builds
• Single unit developments to large multi-unit schemes
• Development Exit Funding or Sales Period Funding – This type of facility is similar to a bridging loan and used to finance a recently completed development whilst the units are sold.
• Regulated Development Finance – Almost all development finance is unregulated, but there are times when it needs to be a regulated facility.
• Mezzanine Development Finance

Types of development project

Refurbishment, restoration and property conversions

Different lenders will have their own definition of light and heavy refurbishment, but generally:

• Light refurbishment – mainly aesthetic rather than structural changes to the property. For example: new kitchen, bathroom, windows and central heating.
• Heavy refurbishment or renovation – involving things like new plumbing, electrics, moving internal walls, partial demolition and rebuild, extensions, attic conversions and converting a property into apartments/flats.

Ground up development projects

Development finance can be used to finance both the land purchase, and also the build costs.

The highest loan to value development finance plans will fund up to 70% of the land cost and 100% of the build costs, provided the loan amount does not exceed 70% of the gross development value.

However, facilities that offer as much as 70% of the land cost and 100% of the build cost, are specialist. Therefore, their interest rates, set up and exit fees, usually all carry a premium, along with also having stricter underwriting criteria.

To obtain the best deals it is best to restrict development finance facilities to 60% of the land cost and 100% of the build cost.

The development finance process

The stages of development finance

How much can I borrow?

When looking at how much you can borrow you will need to factor in:

• land costs
• development costs
• Lender fees – set up fees, exit fees
•  professional costs – solicitors, surveyors, etc
•  contingency costs

You can normally borrow 70% of the land/site cost and 100% of the build cost.

Increased borrowing including 100% development finance is possible.

How will the funds be paid out?

Payments will usually be made in stages as the project proceeds.

• Initial payment to secure the site – typically up to 70% of the site’s current value
• Staged payments throughout the life of the project, in line with the agreed plan of works.  Accuracy is essential when it comes to working out your build schedule and costs in order to ensure adequate cash flow throughout the project.

Do I have to make interest payments during the term of the loan?

Most development finance facilities are set up to allow monthly interest charges to be added to the loan facility. The interest is then repaid when the loan is redeemed.

Having the interest added to the facility takes pressure off the developer so that they can concentrate on the development.

Obviously if units are sold during the course of the development, some or all of the proceeds will be used to reduce the amount outstanding on the development finance facility.

Why do the lenders allow monthly interest charges to be added to the loan?

When undertaking a development project, income is not generated each month, only when the completed development or units within the development are sold. Therefore, there is no regular monthly income, so easier to allow payments to be added each month rather than missed, leading to potential loan default problems.  

How to repay your development finance

All lenders will want to see a clear exit plan before they will agree your loan.  The most common exit routes are:

• Sale of the finished property / site
• Refinancing using a developer exit product – this will usually be at a lower rate, enabling you to clear the original development loan and providing you with finance until the site is sold.
• Long term refinancing – if this is your planed exit route it can be advantageous to have this lined up when you apply for your development finance as lenders will then have the certainty of a clear exit route. Long term refinancing would be used when the developer plan to keep the finished development for themselves to use or rent out.

How Development Finance Facilities are usually Repaid

For every month a development finance facility is outstanding interest charges are being incurred.

Developers will therefore want to limit any delays and ensure any development finance is repaid as quickly as possible.

Development projects are usually repaid through sale or refinance:

Build to sell – when the developer sells the completed development, either as a whole, or as individual/multiple units

Build to rent – which is when the developer refinances the completed development, upon its completion, onto a long term facility, enabling the property developer to rent the new property out.

Or a combination of build to sell and build the rent – this is when a developer sells off some of the completed units and also keeps a number of the units for themselves, in order to rent out as investment properties.

Development Exit Finance

Development Exit Finance enables you to repay any development finance before the sale of the development has been completed.  The main reasons for doing this are:

• To reduce your costs and increase the project’s profit – Exit finance will usually be charged at a lower rate than development finance.
• To tide you over if your current development finance facility is coming to an end and is going to reach the end of its term before your sale is completed.
• To enable you to free up capital earlier, before the sale is completed, so that you can move onto and fund your next project.

Exit finance is often a short term, low cost bridging loan

Why use development finance?

Even if you are in the fortunate position of being able to fund a development project yourself, there are still clear advantages to using development finance for at least a proportion of the costs. 

Advantages of using development finance:

• Finance enables you to take on larger projects than you would otherwise be in a financial position to consider, increasing your potential profits
• Avoids tying up a substantial proportion of your cash until the project is sold.
• By utilising development finance, you may be able to undertake multiple projects simultaneously, or avoid having to wait until an existing project is sold, or is fully sold, before commencing your next development. Using finance can help avoid missing out on your next project or other potentially great opportunities.
• Your actual return on investment rate (ROI) will be greater if you are putting in less capital.  Although you will have the cost of the financing to pay from your profits, the actual rate of return on the amount that you have personally invested will be higher.

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