There’s always been a level of risk in running a property development business, even more so in the current climate. That’s why, for the smaller property developers, having the right development finance in place is key to helping you maximise your return on investment for your latest project. Development Finance is an umbrella term often used to describe any form of finance for a building or refurbishment project. But like the projects themselves, it comes in many different forms. Let’s look at the different development finance loans available in the market.

Development Finance Loans

Development finance is for semi-commercial or larger scale residential projects, including ground-up builds and conversions. Loan amounts of tens of million pounds are not unusual. However, terms can be longer as the schemes are more complex, ranging from 24-48 months, and interest is rolled up.

Drawdown of the construction loan happens in agreed stages as the work is completed and signed-off by an independent project-monitoring surveyor on a monthly-basis.

The value of the land and the cost of the construction are looked at separately but usually as part of the same transaction. Typically, a maximum of around 70% of the total loan to gross development value (LTGDV) can be borrowed. The value is decided based on the estimated value of the property once the development has been completed.

This differs from the more common loan-to-value (LTV) ratio used in Bridging and Buy-to-Let lending, as that is calculated on the current value of the security. For the development work, borrowing can range between 65% to 85% of the total value of the cost of development (loan-to-cost or LTC). This would typically equate to approximately 65%-70% of the overall LTGDV.

Development Exit loans

Because development finance attracts an interest rate reflecting the lender’s risk in the project as it moves through its stages, it can be more expensive than other forms of finance. When the project reaches practical completion, its value as a saleable asset will go up and you will then have the option of moving over to a lower cost loan. If you are holding the project for later sale, or selling it as individual units, the chances are you will want to do this as soon as possible.

With a Development Exit loan, the repayment is geared to the sales plan for the project, and it is worth having a detailed discussion with your lender about this, including the timing of planned sales and what proportion of the proceeds you may be able to retain at each stage.

If you are selling units, the lender is likely to want you to use all the sales proceeds from the first units to reduce the loan until the loan gets to the point of being 60% or less of the value of the security.

Refurbishment Finance

Refurbishment finance is used when completing a substantial refurbishment or minor development of a residential property, with or without the need for planning permission or building regulation approval. This sort of project is often called a “fix and flip” and can include converting a commercial property into residential.

The loan is secured by a first charge over the property and is typically for a term of up to eighteen months. Interest can be rolled-up during this term meaning that both your loan and interest are repaid in one amount when the project is sold.

The amount you can borrow is based on the completed development value of the property, normally up to a maximum of around 70%. Lower interest rates are often available for larger amounts of security cover.

Things to consider with development finance

As with any form of finance, there are some useful things to know both before and after you submit your application.

Your lender will want to know that you have the ability to complete the planned project, so a track-record of past success of similarly sized schemes in similar locations will stand you in good stead. Even with experience, you must be able to demonstrate a realistic sales exit strategy and the ability to service the interest charges.

Most development project are delivered using a special purpose vehicle (SPV), which is usually a stand-alone limited company. You can expect to be asked for a debenture giving a fixed and floating charge over all the assets, and a personal guarantee from any director with more than a 25% shareholding. This amount can vary between different lenders, but typically you should expect to guarantee up to 25% of the loan amount.

If interest roll-up is part of the deal, note when the interest is applied and familiarise yourself with compound interest. Make sure too, you understand the fee arrangements. Arrangement fees and exit fees are common.

Another thing to consider is projects that might not meet a lender’s criteria. Some lenders do not finance basement excavations and certain types of buy-to-let property: freehold flats and properties above fast-food outlets are just two examples of properties that are more difficult for most lenders to take security over. Always check that your project can be financed before committing yourself to it.

Financing all the stages in your project

A development project will go through many stages, and it is advisable to have a finance plan in place from the outset to get it from one stage to the next. There is nothing worse for any project than running out of money.

A bridging loan will give you the space you need to navigate the planning process before carrying out refurbishments or larger scale developments. When you are ready to start work, you’ll need a development or refurbishment loan to finance each stage. At the end, you will want to switch to lower-cost funding while the sale takes place and to possibly release equity for your next development.

Here at Pegasus Finance, funding is our specialist areas, and we’re also good at helping navigate the whole process. We have access to over 600 sources of debt funding and we know how lenders and investors work and what they are looking for. Get in touch with us today and see how we can help and work with you on your next development project.