How to get a property development loan
Whether you’re an experienced builder / developer with a strong track record, or a first-time developer who has acquired a site with excellent development potential, securing finance that’s structured to suit your needs, at the right price, is essential to the successful completion (and profitability) of your project.
What kind of development do you need finance for?
Development finance is a type of short-term property funding that helps pay for building and development costs.
It operates in a similar way to bridging finance, but the significant difference is the scale of projects that can be funded.
Definitions of what counts as a light or heavy development tend to vary from one lender to another:
- A "light refurbishment" project may involve work on ceilings, floor and walls but is generally not structural.
- A "heavy refurbishment" or renovation can involve moving internal walls, adding rooms and external walls and sometimes partial demolition and rebuilding.
- "Ground-up development" is the most extensive type of property work, which may range from a very-heavy refurbishment or conversion, where nothing remains but stonework, demolishing an existing building to rebuild, or starting with an empty plot of land.
A key issue is how many units there will be in the completed development. Lenders are generally reluctant to finance a single unit, such as one high-spec luxury home, where their capital return is dependent on the sale of that one asset.
How much can I borrow on a development loan?
The key factors for lenders are loan amount, the loan-to-value (LTV) ratio of your projected borrowing, how experienced you are as a developer and the number of units you’re planning to build.
Development finance comes into its own for loans upwards of £500K. For a lender, the risks of development finance are considerably greater than for ordinary property lending: for a period their money may be sunk into an empty hole in the ground.
It’s not really worth their considerable survey and valuation costs for loan amounts of less than half a million. The less you borrow, the more it will cost you: there are fewer lenders working in the low-value market, so rates are less competitive.
Lenders are quite willing to lend 100% of build costs – in fact they often prefer to, in order to be confident that there will be sufficient funds to complete the work. But the maximum you will be able to borrow will be 65-70% of the gross development costs (GDV).
This means you will usually be looking to pay for paying for the land/property purchase from other sources.
1 Loans for experienced developers
All prospective developers will be expected to provide detailed plans and cost projections, evidence of their planning application and project management. If you can additionally provide evidence of successfully completed projects you will have access to more advantageous rates – property development loan rates for experienced developers are currently about 0.5% monthly.
2 Loans for first-time developers
It’s more difficult but not impossible for novice developers to access development finance – if you’re able to show a robust cost projection and construction timetable, your planning applications are underway, and you’ve got an experienced project manager and builders lined up.
Reflecting a lender’s increased risk, you will likely be charged a higher interest rate, in the region of 0.7-0.75% per month. And set-up fees may also be higher.
3 Development exit finance
As a development nears completion and is ready for marketing, you may be running close to your repayment deadline for development finance, or it may be cost-effective to refinance with development exit funding on a more advantageous rate.
4 Joint venture finance
Joint venture (JV) funding is a way of making substantial funding available for large-scale developments (such as housing estates or shopping centres), or of financing inexperienced developers.
JVs are temporary but formal partnerships of builder/developers and financers, who share the risks, and the profits, of the project. They’re often managed through the creation of a temporary subsidiary company called a Special Purpose Vehicle (SPV)
How long does it take to set up development finance – and how long can I borrow for?
This is a complex finance arrangement, with building and payment schedules to be agreed between borrower and lender, and legalities to be completed. Realistically you’re probably looking at 6-8 weeks to get money into the bank.
It is possible to get the approvals sooner if you have an established track record, your plans and accounting are ready to be presented, and you have a solicitor who’s experienced in working in property finance.
The standard loan period for development finance is 18 months. Some lenders will extend to 24 or even 36 months for large-scale projects.
How much does development finance cost?
In addition to interest fees you’ll need to pay:
- Lender’s arrangement fee or facility fee: usually 1-2% of the loan amount
- Valuation fees: you will pay the lender’s surveyor’s fees. And if a monitoring surveyor or architect will be tracking the progress of the project you will pay those fees as well. These costs can be covered by your borrowings.
- Broker fees: this is what your broker charges for finding the right lender for your project who will offer the most advantageous rates, for negotiating the details and for packaging your application to ensure it meets all the lender’s requirements and isn’t held up for want of further information. Clifton Private Finance’s fees are usually up to 1% of loan amount, depending on the complexity of the loan application. Our broker’s fee is usually payable when we’ve achieved a formal loan offer for you.
- Exit fee: this a fee of around 2% payable to the lender to wind up the loan facility. Some lenders don’t charge any exit fees, some charge a percentage of the loan amount, and others charge a percentage of the GDV (which will be more expensive). Your broker will make it very clear for you how much you have to pay, and when – and will be looking for the lender with the lowest fees that is most suitable for you.
How does staged drawdown of development finance work?
With development finance the lender’s risk is mitigated by a staged draw-down: funds are released in pre-agreed tranches, after each phase of work is completed and signed off by their monitoring surveyor.
Staged drawdown also helps you, the borrower, if you’re only paying interest on the proportion of funds you have accessed (compared with paying interest on the total agreed loan amount from day 1, as with bridging finance).
If there are discrepancies in building progress or quality, according to the agreed building plan, stage payments may be delayed. This is when it’s essential to be working with a lender who understands critical path method scheduling and won’t create any unnecessary hold-ups in the drawdown of funds – which will be less likely with a specialist development funder than a high street bank.
How is a development loan repaid?
There are a number of repayment vehicles, depending on the size and timeline of the development:
- Sale of the properties on completion of the building works
- Refinance with a buy-to-let mortgage if the properties are to be retained and rented out
- Refinance with a bridging loan as development exit finance, to see the project through to sales completion
When there are multiple units in the development, the distribution of the proceeds of each completed unit will have been set out in the loan agreement.