Whether your plan is to convert a disused factory or build a number of new homes from the ground up, you can make your dream a reality by taking out property development finance. But do you know how these types of loans actually work? What's the best option to fund your project? How much are you likely to be able to borrow?
There are many questions to be answered regarding property development finance, so Think Plutus has created this guide to provide some answers and help you start this venture with all the information you need. Read on to expand your knowledge of UK property development finance and remember Think Plutus is only a phone call away.
What is property development finance?
Property development finance is a type of loan that exists for developers, property investors and landlords to take out on an interest-only basis with a short term. It's aimed at enabling those people to complete their projects if they don't already have the capital to finance them. The loan can be used to purchase land and fund a brand new construction or to renovate and repurpose a building that already exists. In either case, the finished property can be used for residential or investment purposes, or a mixture of both.
Common projects that are funded by property development finance include
- Office blocks
- Housing estates
- Converting commercial property into residential
- Buying land
- Converting to a house of multiple occupation (HMO)
- Industrial buildings
This type of finance resembles bridging loans in a number of ways, but one of the key differences is the way the funds are released. With property development finance, the capital is transferred in staged drawdowns as different stages of the project are reached. Most lenders will carry out inspections of the site before each instalment of the funding is released to ensure the schedule of work (SOW) is progressing in line with the original projections.
In order to secure a development finance loan in the UK, one important thing lenders need from borrowers is evidence of a well-thought-out, viable exit strategy. This means a plan for how the debt will be repaid once the end of the term is reached. Typically, this is through the sale or a remortgage of the development once it is complete.
What are the benefits of property development finance?
Take on bigger projects
By taking out development finance, you will have to put considerably less of your own capital into a project. May people put as little as 10% of the cost of the project forward, borrowing the other 90% in their loan. This means you don’t have to sink all your savings into the project, so that you can:
- Use that money elsewhere if opportunities/needs arise.
- Be less financially committed to the project. It’s rarely a good thing to put all your eggs in one basket and experienced property developers always diversify. Protect your own capital by financing your investments.
Increase your return on investment (ROI)
Property development has a good return on investment. If you are putting less money into the project and only reduce the profits by a relatively small amount, you will achieve far greater returns per £ invested. Business transactions have long been leveraged to achieve maximum ROI and the same principle applies here. Make your money work harder for you by using property development funding.
What's the maximum loan-to-value and the minimum deposit amount?
If you require property development finance to fund both the cost of purchasing the site and of funding the development project, you will find that the majority of lenders will finance 60-75% of the purchase price, which we call the loan-to-value (LTV), then 100% of the cost of the development. The development funding will be transferred in stages as you progress through the project.
Lenders usually base their calculations for the amount they're willing to offer on the loan-to-gross project development value plus the cost. After this, they offset the security's current value against the projected value of the site once the development is complete.
In some cases, it may be possible to obtain a development finance loan that covers the full purchase cost of the site. To achieve this, you would need to put up extra security, such as assets or properties you already own that have equity available. If you want to negotiate this kind of arrangement, some lenders will request a profit share agreement.
For further information about how to secure a loan with a higher LTV, contact Think Plutus today. You will speak to a specialist broker who can take a look at your development plans and offer some realistic insights into the options available to you.
An example of property development finance in practice
Let’s say a client is purchasing a site for £1,000,000 and aims to build 8 4-bedroom homes. The cost of the build would be £1,500,000 and the projected sale price at completion is £4,000,000. This client is an experienced developer whose net worth is strong, and they intend to sell the completed houses on the open market.
- Purchase price: £1,000,000
- Build costs: £1,500,000
- Gross development value: £4,000,000
The client intends to borrow to fund both the purchase and the build costs. The lender offers to lend 70% of the purchase price and cover 100% of the build costs, as long as the total borrowing is less than 90% of the total project cost.
- Original value: £1,000,000
- 70% of original value: £700,000
- Build costs: £1,500,000
- Total loan: £2,200,000
By borrowing 70% of the purchase price and the full cost of the build, the client will receive £2,200,000. This figure is less than 90% of the total project costs (which would be £2,250,000).
The £700,000 required to make the purchase would be released initially whilst the remaining funds would be transferred in increments throughout the loan term.
The final step is to ensure the funds being released meet the lender’s criteria for loan to gross development value (GDV). In this example, the client is able to borrow up to 75% of the GDV.
- Gross development value: £4,000,000
- Loan amount: £2,200,000
- Loan to GDV: 55%
This means the loan fits the lender’s criteria, so the application will proceed.
What do I need to qualify for development finance?
There is no one-size-fits-all criteria for property development finance as it is usually offered on a case-by-case basis. This means lenders may insist on different criteria for another person that they have for you. There are literally hundreds of property development loans on the market, each designed to cover a different type of property development strategy.
There are specialist development funding providers willing to consider applicants with little or no experience, people without a deposit and difficult sites/complex plans. Whatever your circumstances, we should be able to find a lender for you.
Though the rules for eligibility and affordability are not set in stone, there are a few general preferences you can expect from lenders. They will want to offset risk as much as possible, so they will typically require:
- A viable exit strategy: You will not be able to obtain a development finance loan without demonstrating a strong exit strategy from the outset. You will usually pay off the debt by selling the property or remortgaging once the development is complete. You must make the lender feel confident that your exit plan will raise enough capital to pay off your debt once the term ends.
- Clean credit: Though it isn't essential to have a spotless credit file when looking to secure property development finance, it is helpful. However, most property development finance lenders are unregulated, so they have a little more wiggle room regarding what is and is not acceptable. Having bad credit is only really an issue if it jeopardizes the exit strategy but clean credit will help inspire confidence in the lender that the risk level is low.
- Experience in property: Having experience in property is no mandatory as some lenders accommodate first-time developers. However, if you do have a demonstrable record of success in the property industry, you will be in a strong position to convince the lender that your plans can be achieved. There are lenders who will insist on experience, particularly if the development project you are proposing is a complex one.
- A healthy deposit or alternative security: The majority of development finance providers put a cap on the LTV ratio around 70-75% for the purchase, but if you can put down additional deposit or extra security then the level of perceived risk may be lowered.
When they assess an application for property development finance in the UK, development finance providers are looking for evidence that the plans are realistic. To determine this, they will look at the case with a broad perspective, factoring in the variables listed above alongside a number of others. For example, another factor could be the level of experience of your team in handling the work involved in the development project.
To learn more about eligibility and affordability for development finance, contact Think Plutus and our advisers will be able to run you through it and answer your questions. We have access to the full market of finance products and can connect you with the right lender to match the needs of your application.
How long are the terms?
By definition, development finance loans are almost always offered on a short-term basis - typically somewhere between three months and three years. The timeframe for repayment is usually tailored to the details of the project plans, making allowances for things like marketing and sale. Sometimes, a refinance period is offered after the development work is complete in order to execute the exit strategy effectively.
How much will I be able to borrow?
The amount a development finance lender offers is based primarily on the viability of your development plans and the exit strategy. A minimum borrowing amount of £50,000 is often posited by lenders, but there are some who will go lower than that. Many lenders will only offer their most attractive interest rates for larger loans of £500,000 or more.
With regards to the upper end of the scale, there isn't a cap on the amount a development finance lender will provide for a project. As long as your exit strategy convinces the lender that they will recoup the full amount plus interest for the loan, they will be willing to consider providing the amount you require. It isn't uncommon to see multi-million-pound deals take place.
What interest rates are available?
The interest rates on development finance loans are typically higher than standard mortgage rates, so it is of critical importance that you find the best deal available for your circumstances. Once you find an attractive deal, you will need to meet the lender's affordability requirements, and these will differ from one lender to the next.
It's important to note that approaching lenders one-by-one is not the best strategy to find the right deal to fund your property development. Making multiple applications can negatively impact your credit file, and it would involve an unnecessarily large amount of tedious legwork.
Before you take out any kind of loan to fund your property development project, you need to fully understand the costs it will involve. Familiarising yourself with the way interest is charged on development finance is key to this. You may be pleased to know that you will only be charged interest on the funds you have drawn down at each stage of the development, rather than the full amount that is due to be released by the time of completion.
This may look like a big positive, but you need to consider how much the lender will charge for site inspections before each increment of the finding is released. There is no great benefit in taking a low-interest deal if the cost of these inspections cancels out any savings.
The best way to find a deal with the lowest rates and other costs is to work with an independent broker. This will give you whole-of-market access with input and insights from a real development finance expert who can help you identify the deals you will qualify for. Contact Think Plutus today and our advisers will help you find the right lender and the best deal.
What other options are there to finance a property development?
If the information you've read so far is making you think property development finance might not be a good fit, there are some alternatives to look into. Some similar products exist that might be more suited to your circumstances, such as:
- A bridging loan
- A business loan
- Equity release
- Mezzanine finance
- Joint venture
Let's explore each of these in a little more detail.
Bridging finance has much in common with development finance, but the fundamental difference is that payments are not staged with a bridging loan.
A bridging loan can sometimes serve as a suitable alternative to development finance, but there are cases where the two are used simultaneously. We have seen borrowers use bridging to purchase a site without planning permission in place in order to apply for development finance once their planning application is approved.
As development finance includes funding for the construction process, it may actually be more viable to purchase the site via bridging. This is because planning permission can sometimes be difficult to obtain.
However, if you already have the funds to pay for the development, a bridging loan can be an alternative to development finance for quickly securing the site. Having said that, where the project is a large-scale development costing upwards of £10,000, or a -from-the-ground-up' plan, development finance is usually the option to go with.
Whilst development finance is a more popular option for construction projects than commercial loans, there are some scenarios where a business loan might be a viable alternative.
If the borrower has the ability to meet the monthly payments demands of a business loan, and already has the money to pay for construction, a commercial loan could be taken out to purchase the site. Borrowing in this way could also be a good 'plan B' for a project where the works are likely to take some time to complete - things like shopping centres and hotels, for example, often take several years to complete.
You can take out unsecured business loans up to a maximum of £25,000, which could be sufficient to fund a development project in which you need additional capital on top of the money you already have. It allows you to borrow on an unsecured basis, which is attractive for some.
A standard bank loan for property development might also serve as an alternative to development finance much the same as a commercial loan. To learn more about eligibility and what sort of rates to expect, Think Plutus can walk you through and help you make the right call.
If you already have a commercial mortgage or another asset finance agreement in place, you may be able to refinance these existing arrangements in order to release equity from your assets. As long as you have a significant amount of equity available, you could raise a healthy amount of money to invest into a new property/project.
Mezzanine finance won't necessarily work as an alternative to development finance, but it can be used to 'top-up' your funding by using the two together. This can make a huge difference in a large-scale project.
This type of finance sits somewhere between debt and equity finance, functioning as a second charge facility that backs up the first charge development finance loan.
Expect Mezzanine finance to start in the region of £250,000, going up to 75% of the loan-to-gross development value and covering 90% of the cost. This means you will have to put up the other 10% of the cost.
Joint venture development finance is an option to explore if you want to secure a development finance loan without putting down a deposit yourself. In this arrangement, the lender takes a share of the profits once the development is complete.
A typical joint venture arrangement would involve the provider putting up 100% of the cost of the purchase and building work. They will charge interest at a higher rate and claim a profit share somewhere between 40% and 50% when you complete the project. It is standard practice for the lender to establish a special purpose vehicle in the names of both parties and they will want to oversee the progress of the project throughout.
Does peer-to-peer lending exist?
Peer-to-peer lending is a real thing in the development finance sector, but at present it is quite small in scale. You will find that many brokers are cautious about arranging a deal of this kind. For this reason, you should always seek specialist advice before pursuing a property development finance deal that involves peer-to-peer lending. Contact Think Plutus and we'll look into your circumstances and tell you about your options.
Speak to an expert in development finance
If you have any questions to ask, or you just want to discuss things with an expert, contact Think Plutus today for a free, no-obligation consultation. We'll gather all the necessary information about your plans and your circumstances and get to work finding the right option for obtaining development finance. We want to help make your property development goals a reality and through our specialist partners we offer bespoke, specialist advice at every stage of the finance journey. To secure the funds to make your property development plans a success, Think Plutus.