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Development Finance

Wondering what development finance is all about? Check out this informational guide to understand how it works, how much you can borrow, and more.
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Development finance is an essential financial tool for property redevelopment, conversions, and ground-up conversion projects.

Consequently, it serves as a short-term financing solution that plays a pivotal role in covering a wide range of development expenses, from land acquisition and construction costs to legal fees. 

In this informational article, we’ll explore how you can secure development finance against different types of collateral, including land, residential, and commercial properties. 

So, buckle up and let’s kickstart your journey to knowledge and financial empowerment!

What Is Development Finance?

Development finance (loans) is a funding solution that is suitable for various property ventures, ranging from constructing multi-unit developments for profit to regulated self-build projects.

The capital from development loans can be effectively employed for several purposes which include the acquisition and development of previously untouched land, the restoration of existing properties, or the conversion of currently non-habitable structures.

Development finance structures can also be used for churches and barns being transformed into commercial spaces or residential properties showing its reach. .

Due to its adaptability across a myriad of project types, development finance appeals to a diverse range of stakeholders, like medium and small-sized enterprises, large corporations, profit-seeking private individuals, etc. 

Remarkably, it is possible to secure the full amount of required funds under certain circumstances, encompassing both the purchase price and project expenses. 

What Can Development Finance Be Used For?

1. Refurbishment Projects

For light redevelopment and refurbishment projects, especially those involving aesthetic improvements and non-major structural changes, alternative short-term financing options like bridging finance can be more suitable.

2. Commercial Property Development

  • Development finance is commonly employed for commercial property endeavours, such as creating leisure facilities, constructing office spaces, developing retail properties, etc.
  • Lenders often prefer having pre-let agreements in place for commercial projects to maximise loan offerings, although some may consider projects without pre-let agreements.

3. Residential Property Development

  • Development finance is applicable for various residential property projects, including the renovation of existing residential properties, construction of apartment blocks, single or multiple houses, etc.
  • Developers can utilise this financing for both property sales and rentals.

How Does Development Finance Work?

The lending amount a financial institution is willing to provide hinges on the Gross Development Value (GDV) and the associated project costs. An essential step early in the process involves conducting a development appraisal to outline the key expenses of the project.

This preliminary appraisal enables the lender to evaluate the project’s feasibility. Typically, lenders extend a maximum facility of up to 65% of the GDV.

Note that minimum loan thresholds vary among lenders; some may start at £50,000, while others reserve their best interest rates for deals exceeding £1 million, it is very varied in this area. 

One distinctive feature of this financing arrangement is that usually the interest is retained by the lender and factored into the gross loan facility. Consequently, there are no monthly repayments as one would encounter with a conventional loan.

Moreover, initial drawdown funds are usually directed toward property purchase or refinancing if there’s existing debt on the site. On the other hand, build costs are disbursed in arrears as construction progresses. 

How Is Development Finance Structured?

Capital Stack

Development finance can be organised into different tiers or layers. The below is an example however each development case will be individual and have its own set of circumstances. 

1. Senior Debt 

This is essentially the primary charge on the development, similar to a mortgage on a residential property. It holds the highest priority and would be the first to be repaid once the project reaches completion. 

Senior debt typically caps at around 60% to 65% of the Gross Development Value (GDV).

2. Stretched Senior Debt

This is essentially an extension of senior debt, allowing the lender to offer a higher Loan-to-value (LTV) against the GDV. 

Alternatively, the lender may suggest a higher Loan to Cost (LTC) than they would normally, possibly reaching up to 75% of the GDV. It is usually only available to experienced developers due to the increased LTV.

3. Mezzanine Finance 

Mezzanine finance constitutes a form of secondary borrowing, placing it behind senior debt in terms of repayment priority. 

It may be provided by a different lender than the one offering senior debt and can be used to augment available funds, thereby reducing the amount of equity a developer must inject. 

Since it holds a secondary position, it carries higher risk and attracts higher interest rates. However, it can be useful when a developer’s funds are limited, especially if they are concurrently working on multiple projects.

4. Equity From Investors

At times, developers may not possess the full funds required for the project’s deposit. In such cases, they may seek investors who can contribute equity (cash) to the project. 

Typically, this arrangement may involve a profit-sharing agreement with the investor, which might appear more appealing due to the terms offered compared to pursuing mezzanine finance. It is advisable to explore both options depending on the profit-sharing terms.

Interestingly, mezzanine finance may prove more profitable, even with higher interest rates, and allows the developer to retain complete control over the project. However, the investor may seek a certain level of influence over the development process. 

How Much Can You Borrow using Development Finance?

The amount you can borrow hinges on various factors, including the nature and scale of your development project and your level of expertise. 

Many lenders require a minimum loan size of £500,000 but may consider lending up to £25 million or more for the right project and developer.

For smaller projects, there are only a handful of lenders who offer funding for amounts below £500,000. 

When determining potential loan amounts, development lenders typically employ one of two metrics to establish the maximum loan:

1. Loan To Cost (LTC)

Loan To Cost

This is the loan amount divided by the total cost of the project, usually capped at around 85% to 90%, although it could be lower. 

For instance, if a borrower intends to borrow £1.5 million for a project costing £2.5 million, the LTC would be 60%.

2. Gross Development Value (GDV)

Gross Development Value (GDV)

This represents the final value of the development project upon completion, and lenders typically extend loans of no more than 65% to 70% of this value. 

It’s important to note that this figure includes interest and fees, so the actual amount received will be lower.

The longer the loan term, the more interest accrues, further reducing the net loan amount. The lender will then divide the loan into two parts- land loan and build loan usually.

Usual Requirements for a Development Finance Application

  • Application form
  • Bank statements
  • A completed Asset, Liability, Income, and Expenditure form
  • Details of your project timeline and build costs
  • Insurance details of the National House Building Council (NHBC) or other forms of insurance like CRL, Checkmate, or Buildzone
  • Your planning permission documents (certificates discharging planning conditions, approved plans, etc.)
  • An exit strategy (sales and/or refinance)
  • A full project valuation (the lender will normally arrange this)
  • Building regulations consent (initial approved plans)

Development Finance Process

1. Initial Application 

The borrower initiates the process by submitting an initial application to a development lender. The said application includes project details, funding requirements, and information about the borrower’s experience.

2. Lender Assessment 

The lender conducts a comprehensive assessment of the development proposal, considering the following factors-

  • Location of the proposed development
  • Experience of the borrowers and their supporting team
  • Nature and scale of the proposed development
  • The potential end value of the project is referred to as the gross development value (GDV)

3. Development Loan Offer

If the lender is satisfied after all of the full application checks, they provide a formal offer that outlines the terms of the development loan, which may include:

  • Total development loan facility, typically divided into the build loan and the land loan
  • Interest rate and applicable fees
  • Loan term
  • Any other terms and conditions

4. Valuation And Legals 

The lender assesses the proposed development site and works with solicitors to handle the necessary legal procedures.

5. Funds Release

Funds are typically disbursed in pre-agreed tranches or stages throughout the development project. So, borrowers may need to finance the initial stage of the development, after which it will be evaluated upon completion, and the initial funding phase will be released. This process is repeated until project completion.

6. Repayment Of The Development Loan

  • Interest on the loan is typically accumulated and deferred until the development reaches completion.
  • Borrowers may opt to make periodic loan payments during the project.

7. Completion Of The Development

Upon project completion, the loan must be repaid in full. Repayment can be made via the sale of the development or by refinancing with a longer-term loan.

Conclusion 

So, as you can see, development finance plays a crucial role in turning ambitious projects into reality. It provides the essential capital needed to transform ideas into bricks and mortar!

From the initial application to the final repayment, the journey involves careful assessment, financial planning, and strategic disbursement of funds. 

Hence, we hope this informative guide helped you understand the intricacies of development finance and navigate the complexities of your projects successfully.

Your home may be repossessed if you do not keep up repayments on your mortgage.

All content is written by qualified mortgage advisors to provide current, reliable and accurate mortgage information. The information on this website is not specific for each individual reader and therefore does not constitute financial advice.

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