Property Development Finance: Your Ultimate Guide
Suppose you’re looking to tackle a property development or regeneration project. In that case, it’s vital that you carefully consider your funding options, whether you have your eyes on a residential or commercial property.
To elaborate, taking on such large projects requires reliable funding to cover the initial investment and maintain a stable cash flow throughout construction and development.
In this ultimate guide to property development finance, we cover everything you need to know about development loans in the UK, from what they are and what you can use them for to their eligibility requirements, so stick around to find out.
What Is Property Development Finance?
When it’s time for property development companies to start a new project, be it residential or commercial, they often resort to financing in the form of high-interest, short-term loans. Such loans are provided by property development finance companies.
Furthermore, projects that fit the bill include expansive regeneration initiatives, residential housing projects, land plotting, office block construction, and loft conversions.
Otherwise, property development finance isn’t used for small development projects, such as property improvements and home renovations. Instead, these projects require other types of bridging finance.
Also, bear in mind that some property development finance companies only support funding that contributes to residential use. However, others provide funding for both residential and commercial use. Some of the projects that are suitable for property development finance include:
- Commercial development projects
- Residential development projects
- Land and property purchases
- Construction costs
- Development bridging
- Mezzanine bridging
- Pre-planning bridging
- Mixed-use development
- Property conversions
- Property refurbishments
- Part completed schemes
- Buying at auctions
The Different Finance Options for Property Development
There are several property financing options that developers can access based on the type of project they’re working on. This section of the article highlights each option so that you know which one is ideal for your project.
1. Buy-to-Let Mortgages
This is a specialised type of mortgage that allows you, as the property owner, to rent out the entire property or certain parts of it. This finance option is ideal if you intend on using your property to create a rental income.
You may wonder why you shouldn’t just opt for a standard mortgage? Well, most standard mortgages include clauses that’ll prohibit you from letting or subletting, which, in turn, prevents you from using your property to create a rental income.
Additionally, buy-to-let mortgages differ from standard residential mortgages when it comes to eligibility requirements. To illustrate, most lenders will require you to make a 25-40% deposit in order to qualify for a buy-to-let mortgage. You’ll also have to pay high fees. Not to mention, buy-to-let mortgages operate mainly on an interest-only basis.
2. Buy-to-Sell Mortgages
In most cases, the end goal of developing or renovating a property is to sell it. But, unfortunately, taking out a typical mortgage for property development or renovation will most likely lock you in for a few years before allowing you to sell.
Instead, buy-to-sell mortgages help you break out of that mould by allowing quick turnarounds, meaning that you’ll be able to sell whenever you want. The catch here is that such mortgages come with high fees and require large initial deposits.
3. Specialised Loans
Apart from high-street mortgage loans, you can resort to private lenders and acquire specialised property loans. So, whether you’re working on a residential or commercial development project, you’re guaranteed to find numerous private sources that specialise in property development loans.
Finally, please keep in mind that even though specialised loans operate privately, they’re still subject to the FCA’s regulations, which means that fees, charges, and interest rates may vary.
4. Personal Loans
You can also acquire financing for property development through personal loans. Such loans are unsecured, so your property or any other asset for that matter won’t be used as collateral. And they’re more like fast credit loans.
The thing about unsecured loans is that they come with really high interest rates. Also, repayments tend to be fixed, not flexible. Repayment terms tend to be pretty long, though. Keep in mind, however, that you’re obligated to repay your unsecured loan in full before the repayment term ends.
5. Bridging Finance
If you’re looking for a quick, short-term loan that won’t have you paying annual interest fees, a bridging loan is your best bet. Bridging loans are beneficial when you’re looking to sell a property and use the money to buy another property.
Moreover, bridging loans serve as a short-term means of financing the purchase of a new property until you’ve sold your old property. Once you’ve sold your old property, you can pay back the amount you’ve borrowed.
Also, note that bridging loans come in two types: open and closed. And the main difference between the two types is the flexibility of the repayment term.
With open-ended loans, there isn’t a set date on which the loan needs to be repaid in full. In other words, you get to decide how much to pay off and when to pay it. However, with closed loans, there’s a final date on which the remainder of the loan needs to be repaid.
Last but not least, one of the reasons many property developers opt for bridging loans is that they’re available for a wide range of residential and commercial properties. In contrast, high-street mortgage loans are comparatively limited in their purview.
6. Auction Finance
If you’re a first-time property developer, auction finance should be at the top of your list. This type of financing is similar to when you buy a residential property because it provides an agreement in principle. So, the funding is agreed upon in principle, giving you the freedom to bid on your property.
Also, note that the vast majority of properties at auctions are listed at below-market value. This makes them excellent investments for a property developer, whether novice or experienced.
7. Mezzanine Finance
Perhaps you’re currently working on a property development project, and you’re looking to finance a particular part of the construction/renovation process. If so, you should undoubtedly consider mezzanine finance.
Simply put, mezzanine finance is an avenue that property developers opt for when trying to reduce the capital required to raise for their development projects.
With mezzanine finance, funds are provided based on the progress of your project. This avenue of property development finance relies on second-charge loans for security.
8. Portfolio Finance
This type of finance is best suited for professional property developers and investors. It’sHowever, it’s also suitable for landlords. Portfolio finance involves showcasing and consolidating a spangled portfolio of the properties you’ve worked on to secure a loan.
In addition, the criteria as to how many properties should be in a portfolio in order to qualify for a loan differs from one lender to another. For example, some lenders may offer you a loan with a portfolio that has only one property, whereas others require more.
One of the most notable benefits of portfolio finance is that it reduces the overall cost of the development process. Not to mention, it also divides the risk across several properties as a means of maximising the return.
9. Joint Venture Finance
Joint venture finance is an optimal route for many novice property developers who are struggling to raise funds for their projects. As the name suggests, this finance option involves partnering with an experienced developer who can raise enough funds for the project you’re working on.
Ideally, you should partner with developers with enough experience, funds, and networking contacts to turn your project into a reality. This, of course, is done in return for a percentage of the profit you’ll make upon project completion.
How Property Development Finance Works
To start with a property development project, you must first assess your funding situation and choose one of the above-listed options. Then, having determined the ideal funding avenue for your project, you need to decide on the amount you’ll need to complete your project.
And there are a few metrics that you can use to estimate the amount of money you’ll need for a development/renovation project. For starters, you’ll need to know the property’s current value. This can be obtained using a valuation report.
Next, you’ll want to know the cost of the specific type of development/renovation you’re looking to carry out. Is it a ground-up development, or is it a light renovation project?
Lastly, you want to determine the property’s expected value once you’re done with your development/renovation project. With this information taken into consideration, determining the extent of funding needed should be relatively easy.
However, you must keep in mind that not all lenders can offer you the funding you need. In most cases, you’ll be offered a loan that covers the majority of the property’s value (around 70-80%). Still, you may also find lenders who are willing to cover 100% of the development/renovation costs.
Another thing to note is that any loan you take will be subjected to fees, charges, and interest. Fees, charges, and interest will most likely vary based on the amount of money you borrow.
With regard to loan repayment, some lenders will require you to pay back the amount you’ve borrowed once you’ve sold the property. Otherwise, others will be more flexible, allowing you to pay back the loan over a predetermined term.
The Benefits of Property Development Finance
Property development finance has many benefits. The most notable of them is funding versatility. And you can use property development finance to fund a wide range of development and construction projects, including property conversions, refurbishments, commercial accommodation, and land purchases.
Also, another notable benefit is the ability to take on larger, more expansive projects. That’s because property development finance enables you to access large sums of money that the average lender can’t offer you.
With the ability to take on larger projects, you’ll be able to expand your portfolio with varied projects that hold weight, thanks to property development finance. Then, your portfolio will, in turn, help you attract more clients.
Property development finance also eliminates the need to fund projects with your own money. Nonetheless, your project must have a high gross development value in order to receive property development funds.
The Eligibility Requirements for Development Loans
There are quite a few factors that influence whether or not a property development loan is accepted. Nevertheless, before we get into that, we’d like to point out that any property developer can apply for a development loan.
There’s a lender for just about any niche application. That includes everyone from first-time property developers to developers that aren’t able to make initial deposits. There are also lenders for unorthodox or complex property development projects.
Furthermore, you’ll find lenders who work with private developers, domestic and overseas businesses, partnerships and LLCs, and even special-purpose automobile companies.
With that out of the way, let’s discuss the three factors that are most influential when it comes to development loan approval:
Even though many niche lenders are more than willing to work with first-time property developers, there’s no denying that experience matters significantly in this field.
Showing lenders that you have previous experience in the field and that you’ve worked on several successful projects will assure them that their loans are well-placed. It’s also worth noting that lenders are pretty fond of developers who have a team of planners, architects, and builders backing them up.
The aim of the property developer and the loan provider is to generate income from their investment. One way property developers can determine whether or not their project will provide a worthwhile return is to calculate the property’s yield. This percentage represents the property’s rental return with respect to its purchase price.
Additionally, property yield is critical because it influences the rates lenders will offer you. It also plays a significant role in incentifying lenders to work with you.
Gross Development Value
Gross development value, or GDV for short, is another vital factor that loan providers use as a means of determining whether or not a project is lend-worthy. Simply put, a property’s GDV represents its end value.
Most lenders will steer clear of property development projects that cost around 75% or more of the gross development value. In other words, the less the project costs with respect to its GDV, the more the lender is on board.
For instance, if you’re looking to fund a project that costs around 60% of its GDV, you’re guaranteed to find a host of lenders who are willing to work with you.
How to Prepare Your Proposal Applying for a Loan
To increase your chances of acquiring a property development loan, you need to make lenders an offer they can’t refuse. The more secure and well-thought-out your proposal is, the higher the possibility you’ll have of acquiring a loan.
Moreover, your proposal should demonstrate that your project is guaranteed to generate the expected profit. Otherwise, lenders will find your proposal too risky.
Generally speaking, experienced developers will find it easier to secure development loans than their novice peers, which is to be expected, as experience plays a significant role in any field. Nonetheless, there are niche lenders who specialise in working with first-time developers.
In addition, some of the key pieces of information that should be included in your proposal are:
- Purchase price of the land and property
- Building regulations
- Planning permission
- Documented experience
- Exit strategy
- Contractor information
- Overall build cost
- Contingency plan
- Gross development value
- Potential property yield
- Project duration
- Partners (if it’s a joint venture)
It’s recommended that you refer to a financial advisor that specialises in property development as you’re formulating your proposal and application. And remember that the more the risk is minimised, the higher your chances of securing a loan will be.
How Much Does Property Development Finance Cost?
Like we’ve stated earlier, any loan you take for property development comes with fees and rates that may vary from one lender to another, including interest charges, broker fees, arrangement fees, exit fees, and so forth.
Interest charges are typically between 6.5% and 9%. They can be as low as 4.5%, but that’s not very common. Sometimes, loans come with higher interest than specified but with lower fees.
As for broker fees, they’re 1-2%, depending on the type of property development finance you opt for. These fees cover the cost of loan negotiation, which a broker typically does.
Additionally, arrangement fees are 1-3% and are, in most cases, repaid at the end of the loan’s repayment term. Note that the percentages we’re highlighting so far are percentages of the loan value, not the property’s end value (GDV).
Otherwise, exit fees are calculated as percentages of the property’s GDV. Other fees that ought to be taken into consideration are valuation fees, non-utilisation fees, surveyor costs, drawdown fees, and legal fees.
How Much Can Be Borrowed Through Development Finance?
There isn’t a specific range to which we can refer, as lenders tend to assess each case individually. There are, however, factors that influence how much you can borrow through development finance, including the loan-to-cost ratio, the loan-to-GDV ratio, and the day-one advance.
Firstly, the loan-to-cost ratio represents the amount you’re looking to borrow compared to the total development cost. The maximum loan-to-cost ratio is around 80-90%.
Secondly, the loan-to-GDV ratio represents the amount you’re looking to borrow with respect to the project’s expected value once it’s completed. The maximum is around 60-70%.
Thirdly, the day-one advance is the upfront amount that you need to begin the development process. The maximum is around 65-70% of the property’s value.
FAQs About Property Development Finance
Is Planning Permission Required to Acquire Development Finance?
You don’t need planning permission to acquire a property development loan. However, there are lenders who will only work with you if you have planning permission.
Is It Possible to Acquire Finance for a Partially Constructed Project?
It’s possible, but it can be pretty challenging. When you have a partially constructed project, you’ll find that many lenders will be hesitant to get involved. That’s because they won’t have a say in the work that’s already been done. In the lender’s eyes, this increases the lending risk.
Is It Possible to Apply for Development Finance Without Experience?
Most definitely! There are many niche loan providers who are more than willing to work with first-time developers. However, if you’re a new developer, we strongly recommend partnering with experienced brokers, contractors, or architects to boost your chances of acquiring a development loan.
Is It Possible to Apply for Development Finance With Poor Credit?
While most mainstream lenders won’t work with developers with negative credit, there are niche lenders who specialise in working around bad credit situations.
How Is Funding Released in Property Development Finance?
It all boils down to the timeframe set for the critical stages of the development process. The timeframe is typically agreed upon with the lender before the entire process starts. Also, it depends on how much each phase will cost.
Property development finance serves as a means of funding property development and renovation projects without having developers tie up all of their personal savings.
In addition, there are several avenues of property development finance to accommodate all needs and circumstances. So, whether you’re a first-time developer or one with plenty of experience, there’s always a way for you to acquire a loan.
If you’re looking to learn more about property development or if you’re looking to secure property development finance, Clear Commercial Finance has got you covered. So, call us on 0333 344 3216 for financial advice.