Development Exit Finance

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Development Exit Finance (Part 1)

Christian Morris explains how development exit finance works, in part one of a two part episode.

What is development exit finance and what type of loan are development exit loans?

Development exit finance is a loan you would take out when you’re coming towards the end of a development. You already have finance, the original development loan for the purpose of developing the property or properties, and now you’ve come to the end of that loan.

The properties should be pretty much finished – they need to be 85-90% of the way towards completion for development exit finance. It’s simply new finance to pay back your existing development loan. It gives you extra breathing space to finish the project.

You then either sell the property (or properties), which obviously could take several months or, if it’s a single property and you want to keep it as an investment, you have breathing space to take out a standard commercial mortgage or whatever you need on that property.

To explain the difference between a development exit loan and a development loan, the development loan gives you money to carry out the development of the property, to get it to a habitable, sellable state. The development exit loan literally pays back that development finance and gives you time to market that property for sale or arrange alternative finance.

You can also raise some additional money on a development exit loan. You might be 90% there and you just need to finish off the interior, to put a bathroom or kitchen in, for example, and do some decorating. A development exit loan will allow you to borrow money based on the new value of the project. That can give you some additional money to finish the property off and get it to a point where you can then sell or refinance it.

What types of property can I purchase using development exit finance or loans?

You wouldn’t purchase property with a development exit loan. You’ve already purchased that. The development exit allows you to get rid of the development loan that you used to buy and refurbish the property.

Development exit finance would only be taken out at the end of a project where you’ve redeveloped the property and now you’re looking to repay the original finance.

Development exit finance will always come after you’ve purchased a property and worked on it to bring it up to standard and sell it. You’re basically remortgaging, if you like.

You own the property, you have a development loan on it and you need development exit finance to pay back the original development loan. It will pay for any additional work that you want to do on the property, and gives you time to sell it.

Whether you need development exit finance depends on the complexity of the development and how big it is. If you buy a three-bedroom semi-detached house, it’s probably going to be very straightforward and you’re probably going to be fairly accurate with costings. It’s more applicable if you take a big project on.

Do you have an example where a client needed development exit finance?

Yes, we had a client who bought an office in Sheffield city centre and was converting it into 20 flats. As the project went on, things kept coming to light. For example, he wasn’t aware that the building was full of asbestos – it cost him about £70,000 for specialist contractors to remove it.

That wasn’t a cost he factored in at the start because he didn’t know there was asbestos in the building. Various other things also meant he ended up being £400,000 over budget.

Then Covid hit. His builders obviously couldn’t work for several months during lockdown. He lost a lot of time. The development finance company were sympathetic and allowed him to extend by six to nine months, but at the end of that time it needed paying back. When things got back on track, he’d run out of money and the development loan needed to be paid back. So at that point he secured development exit finance.

The exit finance company came in and looked at the work, which had obviously increased the value, and they offered a facility to clear the development loan and added about £120,000 to finish the project.

That gave him 12 months to finish the development and get a commercial loan in place to repay the development exit finance.

Who can take out development exit finance? Can providers lend to first-time developers?

Anyone can take out development exit finance – although you obviously need to have a development. You can’t take out development exit finance unless you’ve got a project to secure the finance on.

A first-time developer would have already bought the property and developed it. When we go for development exit finance you may already be working on your first development, or you could be several projects down the line. Either way, you are categorised as experienced because you’ve already done that development.

Development exit finance isn’t for a property that’s just a shell. The property needs to be weatherproof, with a roof on and windows in. It needs to be 85% to 90% complete before you can get development exit finance.

The only work that should really need doing when you’re applying for a development exit finance loan would be internal work such as carpets, decorating or maybe finishing off kitchen or bathroom installations.

When is development exit finance used? When should I start looking for development exit finance?

Development exit finance is used when you’re coming towards the end of the project.
You should start looking for development exit finance as soon as possible – but not everybody needs exit finance.

You might be developing a detached house, for example, and you have a plot of land with planning permission and you build the property. Halfway through the build, you might sell that property and exchange contracts. When the property is ready, you just complete the sale and that’s it. You have no need for development exit finance.

Generally, you should consider development exit finance before you get to the end. You might be halfway through that build and not be sure whether to keep the property and let it out, or sell it. Maybe it’s the depths of winter and not many people are looking at buying properties.

You may want to keep it and market the property in March when the weather’s turning and the nights are getting a bit lighter, because you think that will be the right time to sell the property.

If that’s the plan, you should start looking at development exit finance when you’re partway through the development, to keep your options open. It obviously depends on the project, the scale and what your intentions are at the end of it. But the sooner you think about that, the better your options will be and the easier it is to go ahead.

What costs do we need to consider with development exit finance? Do I have to make monthly payments?

No, you won’t make monthly payments. The interest on a development finance loan will be rolled up. The interest will be calculated at the end of each month.

When you come to redeem the loan, because you’ve sold the property or you’re going to remortgage it onto a commercial loan, the amount you pay back will be the amount you borrowed plus the interest earned over those months.

The rate you will pay will depend on the circumstances, the strength of the development and the location, but you will probably pay a similar rate of interest as on a standard development loan. The fees, again, would be broadly similar to a development loan.

I’m not going to quote interest rates because the Bank of England can change those on a whim. You could be listening to this in two or three years’ time and interest rates will be completely different from where they are today. But there are plenty of lenders out there – it’s a competitive market and that keeps rates keen.

How much can I borrow with development exit finance? How will my maximum loan be calculated?

When we apply for development exit finance, you’ll need a valuation of the property. A surveyor will go out and look at the project and see if there’s any work left to do. They assess likely costs for getting that project finished.

You can potentially borrow anything from 85% to 90% of the new valuation. When you buy a property and develop it, obviously it will be worth substantially less than once you’ve done the development – you’ve enhanced that property in the meantime. The exit loan will be based on the new valuation, which will reflect the work that’s been done on the property.

Why should I look to take development exit finance?

If you’ve got a project and maybe it’s falling behind schedule for any reason, you may find that the development loan you originally took out will be ending before the build is complete.

You might need another six months, which clearly takes you beyond the term of your development loan. That’s the point where you should be considering development exit finance. It’s a way to move the development loan you originally borrowed onto a development exit loan.

You can possibly raise some additional money if you need it, and it’s going to give you breathing space to get the project completed and either sell the property or refinance it onto a standard commercial mortgage.

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Development Exit Finance (Part 2)

We continue the conversation on development exit finance with Christian Morris, in the second of two episodes.

What information would I have to provide for development exit finance?

It would depend on the development, but broadly speaking, we’d need to know the details of the development and the work you’ve done, the state that you bought the property in and the stage it is now at.

If it’s a big build with structural work, lenders will want to see planning permission, building control and other proof that the development work has been done to the necessary standards.

That could include EPC certificates, because properties now need to be completed to a certain environmental standard. It will be predominantly paperwork relating to planning permission, certificates and building regulations, to make sure the development exit finance provider is happy that the work done on the property is lawful and meets the required standards.

Will a valuation be required?

Yes, it will. A lender will always want to know that the property has been completed to a certain standard and its value in the current condition. Clearly, it will be worth more than the original cost of procuring that property.

How will my project be valued if it’s part complete?

You’ll get two valuations back for development exit finance. First, you get a valuation in its current condition – so if the property is 85% complete, the valuation figure would reflect that.

Second, you get what’s called an open market valuation – the value of the property once the work is completed and it is 100% finished. It’s the valuation you would expect the property to attract if you were to refinance it or to sell it on the open market.

If you’re raising any money as part of the development exit finance, you will potentially be borrowing a percentage of that open market value.

What happens when I start selling the property or properties?

Lenders have different criteria around this. Let’s say your development involves five separate properties and you’ve taken development exit finance on all five of the properties.

A conversation would need to happen between the broker, the development exit finance lender and the person applying, on how to structure the exit. At the start we would decide whether the full proceeds from the first properties’ sales will pay back the development finance, or whether we will just use a proportion of those sales.

Perhaps your five properties are each worth £300,000 pounds. When you sell the first two or three properties, you could use the entirety of those funds to pay back the development exit finance. Then, the sale of the last two would be your profit from the deal.

Alternatively, you might decide that 75% of the £300,000 from each of the five properties will go towards paying back the development exit finance. You’re then taking a little bit off the top from each sale.

That may be a good way to go if, for example, you’ve already sold a couple of properties and you want to keep your development exit finance loan as low as possible. You can then take the 25% from those sales and put it towards the cost of completing the other properties on the development.

It can be quite in-depth, so that’s a conversation to have at the time, looking at the circumstances, the number of properties, where you are in the development and the appetite of the development exit finance company.

How long does it take to complete?

It’s fairly quick. Development exit finance should happen within weeks – and can be faster than that. Usually the longest stage is getting the valuer out on site doing the assessment and then sending that valuation off to the lender.

If it’s a big project and there are several properties on the development, the valuer could be there all day inspecting those properties. So it depends on the size of the development.

You could get development exit financing in three or four weeks if everything goes well. Around six weeks is perhaps the average for getting development exit finance in place.

What happens if I repay the development exit loan early?

Nothing – there’s no penalties. Once you’ve had the development exit finance for a month, you can pay it back at any point. Perhaps you’ve got a 12-month term but you’ve managed to sell a property three months after you’ve taken out the development exit finance.

This finance is designed to be flexible, so if you sell the properties sooner than you’re anticipating, you can exit that loan straight away without any penalties.

How long does it take to arrange a development exit loan? How can I apply for development exit finance?

As I said earlier, the thing that takes the most time is invariably getting the valuation of the development done. The paperwork should be fairly straightforward.

You’ll need to provide the planning permission and the building regulations documentation, but I would imagine you’ll have that to hand. It’s not as though it’s something you did years ago where you have to go rooting around for the paperwork.

To apply for development exit finance, you’ll have to go through a broker. You couldn’t go to a development exit finance company directly. It’s very specialist finance and that’s why lenders want to have a broker involved – to make sure that proper advice is given to whoever is applying for the development exit finance.

What are the advantages and disadvantages of development exit finance?

Not everybody needs development exit finance. I’d estimate that less than 10% of my developer clients actually take development exit finance. It’s quite niche, and it’s only really a necessity for people where the development has overrun and they are coming towards the end of the term on their original loan.

They need to arrange some sort of finance to pay back that development loan and give them the space to either refinance that project, if they’re going to keep it, or to sell it on the open market.

The advantage is that it gives you that breathing space. It allows you to raise extra capital if you’ve run out of money or you’ve overspent on the development. This often happens if you’ve had to spend money on things you didn’t anticipate at the start of the project.

It’s going to give you that time to get the project finished, to get everything sorted, to get the building regulations all signed off. Then you can market the property without a lender breathing down your neck to pay this loan back.

Ultimately, you’re then not a forced seller. You’re not having to accept a lower offer on a property that you’ve just spent 12 months developing. You’ve got exit finance, you’ve paid back the original development loan, and you’ve got 12 or 18 months to then market those properties for full value.

The disadvantages mainly revolve around cost. Obviously, if you need development exit finance then it usually means that the project has overrun slightly and that usually means there are cost issues. There is also the cost of taking development exit finance out.

You’re going to have to pay for a new survey, there will be an arrangement fee charged by the development exit finance lender and you’re going to pay interest on that finance until you’re in a position to repay it.

You would only be taking out development exit finance in certain circumstances, where you’ve run out of money and you just need that extra time to finish the property off and sell it for its true open market value.

Should I use a broker or go directly to a lender? How can a mortgage broker help?

You’re not able to go to a lender directly for development exit finance. It’s very specialist and you need a broker to take you through the process. Even if you’re an experienced developer and you’ve done several projects, lenders want you to go through a broker because every development is different.

You may just be buying a plot of land and building a single property. You may be converting an office. You may be buying several acres and putting up a hundred properties. Every development has its own nuances.

A broker can guide you towards the most appropriate development exit finance lender, that is the most cost effective and suits what you are looking to achieve in taking out exit finance.