Development Finance: How does it work?

Most finance for business or property is a simple loan repayable over a (usually) long term at a modest rate of interest. However, there are some specialisms which have their own peculiarities and are quite different from normal loan finance. One example is development finance and there are many lenders now operating purely in this sector. 

So how does it work?

The first thing to consider is your development experience. The lowest cost lenders want you to have undertaken similar schemes in the past. However, other lenders are more lenient and there are some who will consider a loan even though you haven’t done a scheme before. In these instances, to reduce risk they may want you to employ a reputable contractor on a fixed price contract to deliver the whole scheme.

Typically lenders will fund up to a max of 65% of Gross Development Value  (“GDV” – ie the completed value of the scheme.) There are one or two who will fund to 70%.  This means that if your acquisition and input costs are low, you can borrow almost all the costs of the scheme, without putting much at all into the scheme yourself. Lenders do however have a “base line” input requirement from yourself –  generally a minimum of 10% to 20% of the scheme costs are needed from yourself.

Development lending is generally more expensive than long terms loans. When you think about it, the reason is obvious. Typical development schemes complete in around 12 to 18 months, so the lender doesn’t have the benefit of a long term income stream from the loan. Hence current rates are around 11 or 12% per annum (6 or 7% over base rate) compared to, say 8.5% for a long term loan.

When considering applying for development finance, you will need to have done your homework on the costs and also on what the property will be worth once its complete. Depending on the GDV and the build costs, this will determine what can be loaned day one towards the purchase. You’ll also need to know how long the project will take. If the profit in the scheme is sufficient (around 17.5%), then it can be possible to borrow up to half of the cost of the land and all of the build costs of the scheme – this generally equates to 65% of GDV as mentioned above.

The build costs are usually paid over in staged drawdowns in arrears, some lenders will lend against proof of spend, others may request a new valuation and drawdowns will be based on the uplift in value. Its worth noting that one of the biggest costs with borrowing for development schemes is the monitoring cost. This is the cost of the monitoring surveyor which is passed on to you by the lender and can easily be £750 per month. Therefore when considering which lender to use, assessing the lenders monitoring requirements and costs can be more relevant than the interest rate and set up fee.

Lenders will expect you to have a firm plan in place on how their loan will be repaid. So this will mostly be either a sale of the property(s) or a refinance of the loan if the completed property is to be retained. Either way, it is expected that you will have thoroughly researched the market and options for the avenues.

The lender will generally charge a set-up fee of 2% and also pass on their valuation and legal costs. an “exit fee” of perhaps 1% of the loan amount may be charged when the loan is repaid, but this does vary from lender to lender – some don’t charge at all.

Finally, lenders security requirements, this will generally comprise a first charge over the development site, plus a debenture and a personal guarantee. The personal guarantee means that if you fail to repay the lender the full amount that they are owed, they will pursue you for any shortfall.

If you have a development opportunity and want to discuss your funding options, why not get in touch for a chat.

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