How Does Property Development Finance Work?

14-January-2022
14-January-2022 11:13
in Development
by Jennifer Stevenson
Everything You Need to Know About Property Development Finance

It’s a sobering truth that the success of a build project is often less dependent on the availability of a development site, innovative design or high-quality workmanship than on the availability of affordable and flexible finance.

Development projects require a bespoke and niche form of finance that most lenders don't provide, and securing the right size loan that's flexible and reasonably priced can be a headache at the best of times. Funds need to be swiftly available when required, but not sitting unused in the bank accumulating interest charges before materials need to be purchased or wages paid.

In this guide, we'll cover the fundamentals of development finance, what it's used for, and how to get it. 

In This Guide:

What is development finance?
What are the key features of development funding?
What are the main uses of development finance?
Finance to develop an existing property
Finance for ground-up development projects
Finance for knock-down and rebuild development projects
Example of development funding drawdown tranches
How does the repayment of development finance work?
How much can I borrow through development funding?
What if I'm an inexperienced developer?
Pitfalls to avoid in development finance
Using a Specialist Mortgage Broker for development finance 

What is development finance?

Development finance is a short-term property loan, usually extended for 6-18 months, to help developers with the purchase and build costs of a development project.

You can get a development loan for residential, commercial and mixed-use projects, including ground up new builds, knock down and rebuild projects, and conversions and refurbishments.

The scale of a project can range from a single build to multiple units on a site.

Property-development-plans

What are the key features of development funding?

  • Loans from £200K
  • Short-term finance solution
  • Rolled-up interest (more on this later)
  • Staged drawdown (to facilitate the progression of a build project)

These are complex funding arrangements to set up and administrate, and most lenders are unwilling to consider borrowing requirements of less than £200K.

At Clifton Private Finance, we’ll do our best to find finance for more niche projects if required.

What is rolled-up interest?

Lenders will usually want to see the interest payable on your loan rolled up into the total loan amount and repaid at the end of your term.

This is to allow you to use all your cash for your build and keep your project on schedule, instead of worrying about additional interest repayments throughout the loan. 

The most advantageous feature of development finance is that funds are made available as and when they are needed – so clients don’t pay interest on finance that hasn’t yet been drawn down.

What is staged drawdown?

Staged drawdown on a development loan allows you to only draw chunks of your finance as and when you need it in line with your project. 

You'll only be charged interest on what you have drawn from your loan, so for the majority of your project, you won't be paying interest on the full amount that you've agreed to borrow - only what you've drawn and actually spent so far. 

Development Finance

What are the main uses of development finance?

Here are the three main uses of development finance - we go into more detail for each one later on:

  • Development of existing property
  • Ground-up development
  • Knock Down & Rebuild 

Finance to develop an existing property

If you already own your property, there are a few ways of raising finance for your development plans.

Renovation or refurbishment loans are often used for light or heavy refurbishments on a property you already own.

Light refurbishments could range from basic decorating to a new kitchen or heating system, but don’t generally require any planning permission or regulatory approval.

Heavy refurbishments will likely be significant structural alterations, property extensions or conversions that will require planning permission.

Second Charge Loans:

If you already have a mortgage on your property, you may want to consider taking out a second charge mortgage to raise the additional finance you need. 

A second charge mortgage allows you to leverage the capital you have accumulated in your property through your existing mortgage to get further finance. You'll have two mortgages to pay off, but it could save you from paying early repayment charges (ERCs) on your existing mortgage or losing a great interest rate that you're currently paying if you were to remortgage entirely.

Finance for ground-up development projects

Securing ground-up development finance is a more complex and time-consuming process, and you'll need to have your plans clearly laid out so you can draw down at the right times throughout your project.

An independent surveyor will need to agree to this schedule and work with you throughout your loan term. 

The role of an independent monitoring surveyor (IMS)

Your progressive drawdown of funds needs to be agreed in the loan schedule for your project, and an IMS appointed by your lender (but paid for by you) will make site inspections at each stage to confirm that progress is on schedule before your next tranche of funds is released.

The IMS acts as the lender’s "eyes and ears" on the project and will flag up any potential issues to them.

It’s in both your and your lender’s interest that your project proceeds on schedule, but funding delays can arise if busy developers don’t schedule site inspections with sufficient notice.

Luther Yeates

Luther Yeates

Head of Private Clients

On a well-managed development, the project manager will anticipate that the build will be at progress point X in 7 to 14 days' time, and they’ll need to access the next phase of funding.

They’ll book an inspection with the IMS at least a week in advance, allowing 5-7 days for them to submit their report.

Funding drawdown is usually then available within 48 hours, but it can take a little longer.

 

Finance for knock-down and rebuild development projects

If the majority of your property's value is in its location compared to the building itself, then a knock-down rebuild project could significantly increase the value of your asset. 

Demolishing an old, dilapidated building and replacing it with a modern construction with all the fixtures is expensive, but when you combine a pristine, brand new home with an excellent property location, the realised value can far outweigh the costs. 

But, somewhat understandably, most lenders aren't too keen on the idea of you knocking down a house and re-building.

The risks involved are significantly high. At the very least, if you haven't done your calculations properly then your new property might not make enough profit to cover the interest built up on your loan. Not to mention the endless amounts of uncontrollable outside variables, from the weather, to the availability of building materials or contractors.

However, even if you're not an experienced developer, there are lenders that specialise in this type of development finance and will strive to see the potential in your project and offer you finance, and a mortgage broker can connect you to the right development lenders for your project.

Example of development funding drawdown tranches

  • First-time developer
  • 6-bed, 6-bathroom luxury SW London residence
  • Knock-down and rebuild

Development Loan Example

How does the repayment of development finance work?

Your exit strategy for a development loan is agreed at the outset, and repayment is funded either by:

  • The sale of the property
  • Mortgage finance

On multi-unit projects, developers commonly use the proceeds from the sale of the first units to part-fund the expensive final stages of later units (fitting bathrooms and kitchens and completing landscaping works). 

They'll then take their profit from the sale of the final unit(s).

Professional developers, on the other hand, want to get their next project underway as soon as possible and will need finance to purchase their next development site and progress through the planning process.

To access funds before final sales on your previous project are completed, you may want to make use of development exit finance.

An experienced broker considers all the circumstances of your project, as well as the extent of your development management experience.

For example, If appropriate they'll introduce you to a lender willing to allow an extension to your loan term if a longer sales period will allow a property to achieve its full market value.

We don’t deal with lenders who will be quick to flip you onto a punitive interest rate if you’re not able to meet the deadline of the agreed term.  

Development-finance-Dorset

How much can I borrow through development funding?

The amount of funding that can be provided will be determined by a lender’s valuation report. This will determine:

  1. The current value: the value of the site with planning permission, or the value of the property before refurbishment
  2. Build costs
  3. Gross development value (GDV): the market value of the completed property or properties when all works are complete

Each lender will have its own lending parameters which will determine the maximum amount they’re willing to lend.

A low LTV (50-60%) buys cheaper development finance, and very few lenders are willing to lend above 70% LTV on development projects. 

What if I'm an inexperienced developer? 

It will be more difficult to get finance with no development experience, but not impossible. 

Here are some top tips to improve your chances of getting a development loan without experience: 

  • Have a strong team behind you: an experienced architect, builder and project manager who can each demonstrate a history of realistic costings
  • Experience from your own work that may be relatable, for example as an architect or project manager
  • Sub-50% loan to value (possible if the site is already owned, with planning permission)
  • Getting a fixed-price contract with your builders
  • Most lenders will include step-in rights on finance contracts with first-time / less experienced developers

Property-development-first-fix

Pitfalls to avoid in development finance

Here are some of the most common issues we see throughout development projects:

  • Quantity surveyors being unfamiliar with modular components and building methods
  • Developers changing their plans mid-project and incurring extra costs
  • Hold-ups on the delivery of materials causing significant delays
  • Site managers not giving enough notice for IMS site inspections 

An experienced mortgage broker is essential

At Clifton Private Finance, we have a network of successful developer clients for whom we’ve sourced reliable, affordable and flexible finance on development projects ranging from £200K to £10M.

We work with experienced industry players through to first-time developers: we will look at all the parameters of your project and advise on the most timely and cost-effective funding sources.

Call us to arrange a convenient time to discuss your development plans in-depth:

0203 900 3040

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