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Development finance explained

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Home Commercial Finance Development finance explained

Development finance explained

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About Martin Alexander

Martin has been a mortgage advisor for over 15 years. Check to see if you qualify or call us on 0800 195 0490.

Last Updated on 13th September 2020

If you’re involved in large developments or renovation projects, development finance may be an option to consider.

Development finance can be confusing, even for experienced developers. So don’t worry, we’ve written this guide to explain everything in more detail.

Our advisors are also available to guide you through any questions that you may have.

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What is development finance?

Development finance is a loan used to fund large property ventures such as developments, conversions, renovations and even regeneration projects.

Development finance can’t be used for smaller property projects such as single home refurbishments and ‘flipping’ property.

An example of development finance is explained below:

You’ve agreed to buy a plot of land on which you aim to build multiple properties. The land costs £150,000 and the projected build cost is £600,000. You can use development finance to fund 60% of the plot of land and 60% of the build.

Land purchase price = £150,000
Projected build cost = £600,000
Development finance = £90,000 for land and £360,000 for the build
Funds needed from the developer = £300,000

Using this example, you’re using £300,000 of your own funds. The loan of £450,000 can allow you the freedom to use your own funds for other projects or as a safety net for your existing project.

What if you have a smaller project in mind?

For smaller projects, there are other options.

A bridging loan can provide a quick burst of capital which is usually repaid quick. This is used in situations where you’d need to ‘bridge a gap’ in finances. Many investors use bridging for auction purchases. Homeowners may also use bridging finance if they’re in a chain and need to move out before selling their own home.

Refurbishment finance is another option if you have a smaller project. This is used for refurbishing a property with the aim of reselling it for a profit. The funds are largely used to spend on the refurbishment of a property.

If you wish to develop your own property, you may benefit from a self-build mortgage. Self-build mortgages are for personal projects, such as building your own home and not necessarily to make a profit at the end. That being said, lenders will need to be sure your project is viable.

How long will I have to repay the loan?

Finance for development usually needs to be repaid between six months to two years. The duration of the loan is based on the scale and nature of the development. The longer it takes to repay the loan, the more interest is charged. This is because interest is typically charged on a monthly basis.

Interest is often rolled up and repaid at the end of the term. It’s common to repay the loan in full, either by selling the development or by taking out a mortgage.

Development finance rates

Like mortgages, rates for development finance vary. Nonetheless, approximate rates usually start at 5-6% a month.

Although a number of lenders advertise rates online, they’re generally estimates. Development finance is assessed on a case by case basis as there’s usually a lot of capital involved. Furthermore, each development is unique and needs to be assessed accordingly. Commercial lenders also base their loan rates on the proposition and the credibility of the borrower.

That’s why an experienced broker can be crucial in ensuring you get the best deal offered. Brokers do this by making sure your proposition is structured properly and the deal is negotiated down to the lowest possible rate.

How is affordability for development finance calculated?

The amount you can borrow is based on the gross development value (GDV) of the finalised project. The GDV is simply the value of what your development will be worth at the end of the project. Lenders typically offer up to 60-70% of the GDV and up to 75-80% of the total cost involved.

On occasion, lenders may even lend up to 100% of the total build cost if the total loan is lower than 60% of the GDV. Development finance typically starts from £250,000 with no maximum.

See the example of how affordability for development finance is calculated below:

A developer has secured planning permission on a plot of land to build ten properties. The GDV is estimated at £5 million. The land costs £1 million and the build costs are estimated at £2.5 million, resulting in a total cost of £3.5 million.

A lender may approve a loan of up to £2.6 million (75% of the total costs). Finance is usually released at intervals throughout the development.

Is 100% development finance possible?

100% development finance is possible if you already own some land outright. Lenders will assess the value of your land and proposed build before a loan is agreed. Finance can then be secured against your assets or on the land itself.

Not every lender will entertain a 100% deal, but they are possible.

How to prepare your proposal before applying

Lenders want to see a secure and solid proposal. It’s imperative to have plans and financial forecasts for your proposal ready. This is so you’re able to present lenders with clarity.

Lenders are experienced in the developments they’ll lend on and will base their decisions on how much risk they’d be taking by approving the loan. You’ll need to demonstrate that your proposal has a strong basis to generate your forecasted profit.

Experienced developers may find it easier to secure finance, simply because they have a history of previous projects which can be presented to potential lenders. Nonetheless, if you’re new to property development, it doesn’t mean to say you won’t get finance. Lenders may simply probe further into your proposal and financial status during your assessment.

What should your proposal contain?

An advisor can help you with your application and we’ve listed the key areas you’ll need to consider before applying. Remember, plan well to minimise your own financial risk, not just the lenders.

Your development finance proposal should contain:

  • Purchase price of the property and land
  • Planning permission
  • Building regulations
  • Any previous experience (documented)
  • Information of contractors (builders, architects, contractors)
  • Exit strategy (remortgage, sell, rent)
  • Total build cost (detailed breakdown including materials and labour)
  • Gross development value (GDV)
  • Contingency plan
  • Single, joint or group venture?
  • Potential yield of the project
  • Duration of the project (including stages of development)

Specialist brokers for development finance

Our advisors specialise in development finance. Having an advisor on board can ensure your proposal meets the requirements of lenders. You can also be sure you’re getting the best deal that you’re eligible for.

With such a large amount of finance involved, utilising the experience of an advisor is highly advised. Some lenders are only available through brokers, so you can be sure you’re not limiting yourself. Furthermore, you’ll have access to every lender available.

Brokers can add to your proposal as they know exactly what a lender will look for when assessing your application.

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