Development Finance

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Development Finance

Joe Eden explains all about development finance.  

What is property development finance? How does it all work?

It’s a finance facility to help fund development projects. It doesn’t have to be a full scale development like a ground-up building site. It can be a large refurb; or a conversion from a residential house to another use, such as an HMO – or something else. 

In terms of the structure, it’s similar to a bridging loan. The lender can loan you the money towards the purchase price – 75% is a typical example. But the difference with a development finance facility is you can also borrow money towards the refurbishment or build costs. 

So if you’re buying a property for £100,000 and it’s going to cost you another £100,000 to refurbish, the lender might lend you 75% of the purchase plus potentially 100% of the development cost. The loan is built in two separate tranches.

How much can be borrowed with development finance?

It’s all about the GDV – the gross development value. That’s how much the site will be worth once it’s all built out. For example, if it will be a 20 unit development scheme worth £6,000,000 once finished, that’s the GDV. 

Some lenders will base their lending based on that figure, while others will be more heavily focused on the Loan to Value or Loan to Purchase Price. These lend based on the purchase cost plus the development cost. 

Lastly, some lenders use a formula called Loan to Cost. So if the project is going to cost you £500,000 to buy and £500,000 to do the development work, they might lend you 80% of the total cost, or £800,000.

Can I get 100% development finance?

Yes, but it is a lot harder in the current market (podcast recorded in January 2023). Some people think you can just go into a development and build it and it’s all perfect. But there’s a lot of risk and stress that contractors and developers generally go through. 

It is tough to get 100% development finance because of that risk. Most lenders want you to have some ‘skin in the game’ – which means having some physical assets or money tied up in the project. 

But there are different ways we can raise finance for development. One route is to have one ‘senior lender’ – a first charge lender who provides a certain amount of the purchase price or build cost. Then we can do what’s called mezzanine debt, where a second charge lender sits on top of the first lender. 

Some will lend up to 95% loan to cost. So if your total expenditure is £1million you might just have to find around 5% of that total cost. We’ve got a couple of lenders that will allow that type of structure. 

Who is eligible for development finance and what criteria need to be met?

It’s very tough to get development finance when you’ve never done a project. Experience is really important. If you’ve never done a project but you have a background in quantity surveying or project management from your career, there could be some options, but typically lenders want you to have done a similar scheme previously. 

They want you to demonstrate that you’ve done this kind of thing ideally for yourself or potentially for a client. If you’re a builder and you’ve built something for a client and now want to do it yourself, that’s perfect. We could certainly look at that. 

The second requirement is assets. Development lenders want you to have a certain amount of assets in your name. They’ll do what’s called Means Tested Personal Guarantees. When you enter into a development finance agreement, the lender wants you to sign a personal guarantee that if the project goes wrong, they can come after you personally. You can’t liquidate the company and run off. With a Means Tested Personal Guarantee they will check you have some assets. 

If you don’t own your home or have an investment property or other sources of money, they won’t want to take you on as a borrower. Some lenders will have a set ratio, where if you’re borrowing £1 million they might want you to have £200,000 in assets, which is 20% of your overall borrowing. 

How much does development finance cost?

Development finance is a little bit more expensive in terms of fees than bridging. Some lenders would charge a 2% arrangement fee and a 1% to 1.5% exit fee. Overall you might spend around 3.5% in fees on development finance. Again it’s all relative to the project. 

Interest rates are similar to bridging and auction finance. It will be a monthly interest rate which typically starts around 0.7% to 1% per month. If you only had that facility for six months and then repaid it, you would only get charged for that six month period – you’re not going to be overcharged because you’ve paid early. 

You’ll also have valuation fees, which can be a lot more expensive than with bridging. There’s more due diligence for the surveyor to go through, more values to check plus comparisons if there will be multiple units in a scheme. There will also be lender’s legal costs as well – some developers don’t factor these into their appraisals.

When do I need to repay a development finance loan?

As most people know, when you’re planning a project and think it’s going to take six months, it’s probably going to be 12 months in reality. So having some contingency in your timescales is important.

Lenders will look at your time planning. If you say you need six months’ development finance and the lender thinks the project will take longer, that may lead them to doubt your credibility. They might wonder if you have done a project before. So I always recommend adding time contingency into your plan. 

But ultimately, you tell the lender how long you want the finance plan to run. You could have a six month finance facility or less, or up to 24 months’ facility. Just always make sure you’ve got extra time built in – just in case the contractors go over time, or it takes your buyers longer to complete, or you hit other issues. 

I’ve had friends and clients who haven’t been able to finish their project in the required time. In this case you either sell the site very quickly to pay the lender, or you can do what’s called development exit finance, which is essentially refinancing to a new lender. That will cost new arrangement fees and new interest rates, so be very cautious of that in your time plan..

Speak To an Expert

Our typical process is that someone will get in contact with us or they might be referred to us by an agent. We’ll have an initial five minute chat to address any burning questions, then we’ll set up a Zoom call or a meeting and spend an hour or so going through your affordability and any advice that we can offer at that stage.

That’s entirely free. No matter what type of finance we do, whether it’s residential, Buy to Let, bridging finance, we don’t charge a penny until we physically apply for a product for you.

What are the pros and cons of development finance?

Starting with the pros, you can leverage at quite a healthy level if you wanted to. If you’re a contractor building houses day in, day out, you may not need loads of capital. But generally you don’t need as much as you might think. 

Development finance can be really creative in terms of how lenders structure deals. Ultimately, if you can borrow the money to fund the development cost, that’s the biggest pro – because it doesn’t have to come out of your pocket. 

The biggest disadvantage of development finance is that the upfront costs can be quite high, especially on a big development. As an example, we’ve had quotes this week for a new 21 unit scheme and the valuation fee is £5,500+. If the surveyor then visits the site and doesn’t like it or downvalues it because the figures are slightly wrong, that fee is non-refundable. We may have to try a new lender or pull out of the purchase. 

How do you apply for development finance? 

Similar to bridging and auction finance, find a good broker – it’s really important. There can be very quirky, very different fundamentals in how lenders work, and the relationship is important. 

If we’ve done ten deals with one development finance lender we can structure and position your project in a positive way. We’re more likely to get the deal over the line if we know that lender and their current appetite. 

So just find yourself a good broker who has done this type of work before. A lot of brokers portray themselves as able to do development finance and auction bridging because it can be quite profitable. But you need the knowledge and skill to execute it – otherwise it can be really expensive for the borrower. I recommend asking a broker for examples of deals they’ve done in the past.

What if I have bad credit – how would this affect the application process?

For anyone who hasn’t listened to the auction finance and bridging finance podcasts, some lenders would insist that you do a Retained Interest option. What that means is that you pay your interest payments upfront. You don’t have to make any monthly payments because the lender’s already got the money, making it less risky for them. 

If you repay that loan back after six months they’ll refund you the interest you haven’t used. It gives the lender more control, and most of them will want to do that – to take the interest all upfront. 

So bad credit isn’t irrelevant, but it doesn’t cause as much of a problem as with other borrowing. Bad credit might suggest that you haven’t paid your bills, but as the development lender would retain that interest upfront, you have no choice but to pay them back.

What I would say is that the more you have going against you, the harder it would be to get underwriting. With development finance your case, your asset statement, your income and your residency – whether you’re in the UK or not – will all go to an underwriter. They’ll review the whole case as one. 

If you’re an overseas resident, you’ve got bad credit and aren’t putting in much capital into the project, all these little things could mean you have less chance of approval or will face higher costs. You might get a higher interest rate because the lender feels it’s more risky.

What else should we consider with development finance?

Just speak to a broker before you start looking at projects. We’ll help set out some parameters in the deals you’re looking at. Sometimes we see people go and agree prices and are way out on the figures – or they don’t have enough cash to fund it. 

Sit down with a good, experienced broker to make sure that your project ticks the boxes. If you were to agree to buy a site with planning for 10 houses but you’ve never developed before, you’re not going to get finance. You might need to partner up with someone with the necessary experience. Don’t ruin your own reputation with an agent by getting a deal agreed and then having to pull out because you haven’t looked into the financials in advance.