The Easy 6 Step Guide to Development Finance
How does development finance work and what are the criteria? Below Gary Hemming at ABC Finance explains the ins and outs of project financing and development loans in the property sector and beyond. What is development finance? Development finance is a type of short-term, secured finance which is used to fund the conversion, development or […]
How does development finance work and what are the criteria? Below Gary Hemming at ABC Finance explains the ins and outs of project financing and development loans in the property sector and beyond.
What is development finance?
Development finance is a type of short-term, secured finance which is used to fund the conversion, development or heavy refurbishment of property or properties. Property development finance can be used for a range of different building projects but tend to be used for ‘heavier’ projects, which require serious building works.
Projects which require ‘lighter’ works, such as internal refurbishment are likely to be better suited to a bridging loan.
How does it work?
Development finance can be more complex than residential mortgages, with funds advanced upfront and then throughout the build.
Funds are initially advanced against the value of the site, with most lenders happy to advance up to 60-65% of the value.
Once the build has begun, further funds are released at agreed intervals, with lenders often willing to advance up to 100% of the build costs. In order to agree to each stage release payment, the site will be re-inspected by either a lender representative or monitoring surveyor. If they feel that works are being done to a high standard and there is sufficient value in the site to release the next stage, funds will generally be released quickly.
The reinspection and further staged drawdown are then repeated until the project is completed.
How is the interest paid?
The interest is retained by the lender as each stage is drawn down, meaning there are no monthly payments to make. When the development is complete, the loan is redeemed along with any interest that has accrued.
This generally suits both the borrower and lender as cash flow can be difficult to mage during a build. As such, the removal of monthly payments makes the loan easier to manage for all parties.
How much does it cost?
The rate charged will depend on several factors, with the main ones being
- The developer’s experience and track record
- The scheme being undertaken
- The location of the development
- The amount of funding required
- The loan to value/loan to GDV requested
Larger loans of say £500,000 or above will usually be between 4-9% per annum depending on the above factors.
Smaller loans of say below £500,000 will usually range from 9-12% per annum however if the deal is strong you could pay around 6.5% per annum. Usually, lenders price each application individually.
In addition to the interest charged, the will usually be a number of other fees, the main ones are:
- Lender arrangement fee – this is usually 1-2% of the loan amount
- Lender exit fee – this is not always charged but can be 1-2% of the loan amount.
- Valuation & monitoring surveyor fees – these can vary and it is almost impossible to offer a guide due to the number of variables.
- Broker fees – most brokers will expect to earn 1% for arranging a property development loan. Where they are not paid by the lender, they will usually charge it as a broker fee directly to you.
Understanding the maximum loan available
Property development finance lenders use a number of key metrics to calculate the maximum loan, they are:
- Loan to value (LTV) – The loan to value ratio is used to calculate the maximum available advance at any one time. The monitoring surveyor will revalue the site throughout the build to ensure the lender is never overexposed.
- Loan to cost (LTC) – Most lenders will want to know that you are putting up a certain amount of the money yourself, loan to cost is used to calculate this. For example, a maximum loan to cost of 90% would mean that the lender is not willing to put more than 90% of the total cost of works into the scheme. You would, therefore, have to pay at least 10% of the total project cost by way of deposit.
- Loan to gross development value – Otherwise known as loan to GDV, is the maximum percentage of the loan that the lender is willing to offer. If a £1,000,000 scheme had a maximum loan to GDV of 70%, the maximum total facility would be £700,000.
The lender will combine all 3 of these metrics to calculate the maximum loan. Where there is a conflict between the 3 figures, the lower of the 3 will be chosen to cap the loan.
What happens when construction works are complete?
When the works are complete, the loan will generally need to be repaid. Often, people look to refinance to a term loan such as a mortgage or switch to a development exit product whilst the site is sold as this can be cheaper than the development finance, maximising profit.
The facility will be set up to last for only the build period, with a grace period to allow time to refinance or sell. Development finance should never be used as a long-term finance solution.