Development Finance for First-Time Developers
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Development Finance for First-Time Developers
What are the requirements for obtaining development finance for first time developers in the UK?
There are lots of lenders out there that will lend to first-time developers. Obviously, first-time developers don’t have experience of handling a project, so lenders look for evidence that you’ve done your homework.
That means you’ve engaged architects and maybe a quantity surveyor, depending on the size of the development. They’ll want to know who your contractor is to carry out the work and whether that company is experienced in the type of development you’re planning.
It’s mainly about the professionals you’ve got in the background. Are they experienced, in lieu of you not having that history as a first-time developer? And are those people you trust for advice and help experienced in the right areas?
What exactly do we mean by development?
There are all kinds of levels and scales. You could buy a three bedroom semi-detached house and develop that into a six bedroom HMO or a five bedroom property. You could build a bedroom over the garage. You could extend the kitchen out at the back.
The size and scale of the development will shape the lender’s requirements. Where you are going to struggle as a first-time developer is aiming too high, too fast. Perhaps you have an opportunity to buy a plot of land with planning permission for say 15-20 houses.
But ideally you will have previously done a small scale development – a property conversion or a major upgrade – maybe converting a bungalow into a bigger property with five bedrooms and an extra floor.
Lenders for a big development would expect you to have started somewhere, so that you know the planning process, how to deal with architects and quantity surveyors, the health and safety implications of the site and dealing with building control.
The vast majority of first-time developers do recognise that. In 25 years I’ve never had somebody wanting to buy land for 20 properties who has never done this type of project before. Usually people start with one property, develop it, sell it on, and move up as they get more experience. Their confidence increases every time they succeed. It’s a learning process.
Can you explain the different types of development loans available for first time developers in the UK?
There are two different types of development finance. The first one is where you already own a property and you’re looking to change it substantially. Or, maybe you own a piece of land and you’ve just got planning permission to build a property there.
It could be that you own your residential house, you’ve got a really big garden and you’re going to parcel off a piece of that land and build a property on it. You create two separate titles, one for your house and one for the new property.
You’ve applied to the local authority and you’ve got planning permission for, say, a four bedroom detached house. You need the finance just for the development. In that situation, the lender would want to see the plans, the costs from the contractor and they would be prepared to lend up to 100% of the development costs.
If your development costs are likely to be £250,000 to build this four-bedroom, detached house on a piece of land you own, you could borrow all of that money.
The other type is where you find a property that you want to develop on a nice big plot. In that case, development finance can give you 75% of the purchase price of that property, and then 100% of the finance for the development works.
That works in two stages. You will buy the property with 75% of the purchase price – so you put a 25% deposit in. Then, when you own that property and have planning in place, maybe four or five months later, you ‘draw down’ the development loan.
What are the key factors to consider when comparing different development finance options for first-time developers?
It’s important to look at when you can draw the development loan down. Again, we’ll use the example of the bungalow being converted to a five bedroom detached house.
If you need £200,000 to do that development, you won’t get all that money in one go. When the builder starts work and they’ve done a certain amount, the lender releases a tranche of perhaps £50,000. When they’ve done another part of the work, they release another £50,000.
Usually you would draw the money down in two, three or sometimes four stages. After each stage, the lender sends out an asset manager or quantity surveyor to look at the work done. If they’re happy with that, they release the next tranche of money and you go on to the next stage of the build.
You need to be aware how a development finance company will charge you. Most will charge you interest when you draw that money down, but some don’t – they charge you for the full facility, even if you don’t use it. Now, I just think that’s wrong. If you’re not drawing down the money, you shouldn’t be paying for having that facility.
Also, find out how they charge the interest. Is it on a daily or a monthly rate? That’s important, because if your development is ready and you’ve already sold the property or you’re about to remortgage it, if you complete on the 10th of the month, you may pay interest until the end of the month – even though for 20 days you don’t have the facility.
That’s where a good finance broker comes in. The lenders want to work with you as the developer to get the project done successfully. They want you to make a profit, because they’re lending money to make money. At the end of it, if you have a pleasant experience and you’ve made a decent profit, they want you to come back and do it again.
Use a good broker who knows development finance – we steer you towards the best development finance companies for first-time buyers and make sure you get a deal that fits your requirements exactly.
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How does the loan application and approval process work for first-time developers seeking development finance in the UK?
There will be a greater emphasis on having good professionals behind you: architects, quantity surveyors and contractors with experience in this area.
You would expect architects and surveyors to have that sort of experience, so ultimately it boils down to the contractor. Those contractors bring the whole development together. They will contact plumbers, electricians, plasterers and all the various tradesmen for that project.
Again, it depends on the size of the development, but they will handle the whole thing for you. For a first-time developer, that is what the development finance company is looking for at the application stage.
They’re looking to see you’ve done your homework, you’ve got the planning in place and you’ve got a contractor to bring the project together to make sure it comes in on time and on budget.
What are the potential risks of taking out development finance as a first time developer? How can they be mitigated?
The biggest risk is not using knowledgeable contractors. It’s crucial that tradespeople are reliable, turn up when they say they will and do a good job. One of the risks is that you engage a contractor who does two or three weeks work and goes off for a week on another project.
Get as many references as you can, do the research. Speak to people who those builders, plumbers and electricians have done work for before. Check their qualifications. There are a couple of websites that will tell you they’re reliable.
The other big risk, of course, is that the project overruns. Something you anticipated would take nine months could end up taking 18 months. Then, that property you’re planning to sell or rent out is not ready. You’re still paying interest on the development finance. You haven’t yet realised the equity you’ve built into the property.
It’s important to have a contingency in place. If the development overruns, have you got the funds in place to continue? It could be that the development is done on time, but it’s November and people aren’t buying property. It’s winter and everyone’s got one eye on Christmas.
It’s often not until spring that people start looking to buy property. Can you survive until spring? You need to know what your end game is. If it’s selling the property, what time of the year will it be ready? If you’re letting the property out, that doesn’t really matter. You should find tenants all year. So always have a plan and a contingency.
What should first-time developers look for in a mortgage advisor or mortgage broker when seeking development finance?
If you’re a first time developer, find a broker who’s got knowledge of the development finance arena. The lenders have various different quirks around how they will lend. Some won’t do big projects and only do small-time developments on single properties.
Others will consider a bigger project. Some specialise in converting properties into HMOs.
Some specialise in ground-up developments, where you buy a piece of land or you own land and you are starting literally with the foundations.
A broker and their experience in this market can be pivotal to getting the project completed on time and making a profit. Getting the right development funder in place is a massive piece of the jigsaw in making your project a success.
What are some common mistakes that first time developers make when applying for or managing development finance? How can they be avoided?
The big mistakes are not doing your homework, and not understanding the market. If you want to turn a three bedroom property into a five bedroom detached house, are there similar properties in that area?
If this will be the only five bedroom detached on that street, will you get the price you think at the end of this project?
You need to plan through every stage of this. Can you get planning permission? Do you need it or can you do it under permitted development rights? You can usually get that off the local authority website.
Is there a market for this type of property if you are going to rent it out? What type of tenant are you targeting in that street? Is there a market to sell the property? If there are lots of properties similar to the one you’re intending to develop, that’s great. You’ve got lots of evidence on the prices those properties are selling for.
You can work backwards from there. Those properties might be selling for £300,000, you buy for £150,000, then perhaps it will cost £75,000 to do the development. The total is £225,000. You’ll have some skin in the game if you can sell for £300,000 at the end.
The other big mistake, apart from lack of planning, is not having a contingency budget. If you need to borrow £100,000 on development finance to completely redevelop a property, I would add at least 10% or 15% to that for contingencies you don’t expect.
Without that contingency, if there’s an issue, like needing to pay for a full rewiring of the property that wasn’t anticipated, you could end up 95% finished and run out of money. That’s extremely frustrating and obviously costs you. So always factor in a contingency fund for those unexpected things.
Can you provide any examples of successful first-time developers who have obtained development finance in the UK?
I’ve got a client whose specialism is to buy property that’s run down. He often buys properties from probate, where an elderly person has lived in that property and hasn’t done any work to it for several years.
It’s being sold by the estate, which means people are looking for a quick sale. He will buy that property using development finance and then refurbish it to a high standard. He either keeps that property in his portfolio and rents it out at a high end rent, or sells it if he’s built a lot of equity.
He started by converting a three bedroom semi-detached property into a six bedroom HMO.
He got planning permission and put an extension over the garage, adding two bedrooms. He also converted the loft into a bedroom. He started about five years ago and we walked him through the process.
He had really good professionals working for him again, architects, quantitative surveyors, contractors. He’s now got 60 properties and has done some sort of development work to all of them. He’s constantly on the lookout.
He has relationships with estate agents – and that’s a good tip for first-time developers.
You can find out what’s coming onto the market and they will give you a call before advertising the property.
When my client created that six bedroom HMO, instead of getting a rent of £600 for a really tired old property, previously owned by someone who passed away, he was getting £1,800 a month once the developments were done. He’d added about £100,000 to the equity of the property, as well.
What else do we need to know about development finance for first-time developers?
It can be lucrative if it’s done right. It can be a really good opportunity for you to make money and develop properties that are old and tired.
Some developers take properties that have an energy performance certificate rated E and they’ll bring it up to a C or a B. They’re doing their bit for the environment and future-proofing those properties. As well as the financial reward, it can really give you a lot of satisfaction.
Just make sure you find people who have worked in this area – contractors, your mortgage broker – and that they know this market inside out. They will give you all the advice you need to get your project through successfully on budget and on time.
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