Development Finance

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Development Finance

Christian Morris from Maple Leaf Financial talks to us about development finance.

Podcast approved by The Openwork Partnership on 16/08/24.

What is property development finance and how does it work?

Obviously, the key is in the name. It is a finance facility that allows you to develop a property.
For example, you might want to refurbish a property and bring it up to a better specification.
Development finance could also apply if somebody owns a piece of land and has planning permission to build a property there. If there’s no current structure there, that would be what we call ‘spade up.’ They’re going to start by building the foundations and create the whole property from scratch.

There are usually two elements to development finance. If you don’t already own the property, acquiring it is the first part of the loan. Then, when you have taken possession of the property, that’s when the second part of the development loan comes in – which obviously funds the refurbishment or build of the property.

How much can be borrowed with development finance?

The development funding, which is usually the second part of the loan, is usually for 100% of the build or development cost.

If you’re buying a property that is run down and not habitable, that doesn’t have gas, water or electricity, for example, they’ll usually lend up to 75% of the purchase price. That means you will be expected to commit at least 25% deposit to the purchase of the asset. After that, 100% of the development funds could be financed going forward.

Imagine you’re buying a property for £200,000, and you want £100,000 to completely refurbish it. You’re going to strip it out, put in gas, water, electric, new central heating, new windows, maybe a new roof, completely redecorate and make it a really good property. The lender will fund that £100,000.

The vast majority of development is fairly straightforward. It may be to build something commercial, like an office in a city centre. Or it could be a property to ultimately rent out, or sell back onto the market in 12 months’ time – which is known as flipping.

They’re fairly straightforward in so much as you won’t have a problem getting funding, as long as everything else stacks up. But the less standardised the assets, the more a lender is going to want you to have previous experience of those projects, before they would release 100% of the development funding.

Can I get 100% development finance?

In 95% of developments, 100% funding is possible. I’ll give you an example where you may not get 100% development funding. I had a client who wanted to build a battery storage plant. The offshore wind farms in the North Sea, and solar panels would feed into this battery storage plant.

When the wind wasn’t blowing or the sun wasn’t shining, the battery feeds energy back into the national grid. We weren’t able to get 100% development funding for that because it was such a unique asset.
However, the client did have experience of building these projects. He’d done it successfully before. We did manage to get development funding, but you would struggle on that sort of project to get 100% funding. On day-to-day properties, 100% funding is no problem.

Who is eligible for development finance? What criteria needs to be met?

Pretty much anyone could apply for development funding. You don’t even need to have experience.
As long as the project is viable, there are various things a lender will look for to make sure that the end value will justify the money they advance for the development. That’s called the GDV, the Gross Development Value. That’s the final value of the asset.

There are funders out there for inexperienced developers because, ultimately, everybody has to start somewhere. Some will fund commercial assets, some will fund residential assets.

How much does development finance cost?

It’s a tough question – because the more standardised the project, the cheaper the finance is going to be.
If you’re buying a house that’s run down and neglected, that hasn’t had any work done to it for a long time, and you’re going to refurbish it up to a really good specification, you may improve the EPC – the environmental effectiveness of the property.

That’s a pretty standard development, so that will be fine. If you were for something that is less mainstream, that’s potentially going to cost you more money. If you’re a little bit inexperienced, as well, a lender may be happy to lend but at a slightly higher rate.

Being inexperienced isn’t a big blocker to getting finance. But once you’ve got your first project completed, we could show a funder that successful result, where you’ve either sold it or let that property out. The rates will then be standard rates.

I won’t quote rates here because as you know they could change. Usually with development finance, the interest is charged on a monthly basis.

So if you’ve got a project that’s only going to take three months to complete, and then you’re going to refinance to a standard mortgage or sell the property, you would only pay interest for those three months. It’s not long-term finance.

Most development loans are probably for 12 to 18 months or less. It depends how much work the development is going to require.

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When do I need to repay a development finance loan?

It depends on your plans at the end of the project. What are you going to do with that completed property? Are you going to live in it yourself? In that case you’d apply for a residential mortgage, which would pay the loan back.

Or, perhaps you will let the property out, In which case you would look at a Buy to Let mortgage. Obviously that mortgage will pay the development finance back. Or, you could sell the property, so you would go to an agent and put the property on the open market. When you had a satisfactory offer, that money would come in, you’d complete the sale and the development funding would be paid off.

You would usually take a development loan over a longer period of time than the anticipated development timescale. So if you think you’re going to need three months to complete a project, you will probably want a nine or a 12 month term for the finance. The reason for that is that if things overrun and it takes you four months before the project is ready, you’ve still got the additional months to market the property or to apply for a Buy to Let mortgage.

So it’s not just a case where if a development is going to take me three months, you only need three months’ development finance. At the end of three months the project’s ready but the funder will want their money – so you need to give yourself time to market the property.

Always think about how you’re getting out at the end of it, what your plan is, and give yourself sufficient time.

What are the pros and cons of development finance?

The pro of any development finance is that it allows you to to develop a property. Most people that take development finance want to make money on a project. They either want to sell the property at the end of it or to increase the specification of a property for tenants who will pay a really good rent.

Obviously, the value of the property will go up because you’ve improved it. Development finance allows you to do that. And, as we touched on earlier, they will fund 100% of those development costs for you.
At the end of it, you should have a really good asset with lots of equity in it, to make you money on the project. The other thing is that the development funder will always work with you to get that project completed on time. On a more in-depth development, they may send out a quantity surveyor or an asset manager every few weeks to check progress and make sure everything’s on time.

If you’re fairly inexperienced, the funder will help you and hold your hand throughout the project, as well. They have an interest in you getting it completed and being able to sell the property or take alternative finance.

The big drawback with development finance is that sometimes things could prevent you completing on time. I’ve had so many projects that have fallen behind schedule because it’s just not stopped raining, for example.

You should consider things like that. One client bought an old office to convert to residential flats and when they stripped the walls back they found asbestos. That took about two months to address. The contractors had to be specially qualified to remove asbestos from the building.

That was a cost and delay he hadn’t anticipated. But development finance lenders understand that things like that will happen and they’ll work with you as the developer to help you overcome these problems.

With the asbestos, they were happy to extend the facility beyond the original term. There were no cost overruns. But always allow a bit of a buffer for eventualities you can’t anticipate at the start of the development.

How do you apply for development finance?

We could look at the project for you. I could give you some feedback, as we’re experienced in development finance. You would need to do your homework, looking at properties in the area at the specification that you’re intending to develop to. What sort of prices are they selling for?

Speak to two or three different builders and get quotes for the work involved. Make sure you’ve got a ‘schedule of works’ detailing everything you’re intending to do to the property and the costs involved with that.

Once you’ve got all that, we could approach a development funder and present the works, the builder, the costings and the GDV at the end. You’re buying a property for, say £200,000 and spending £100,000 on it. But at the end of it, it’ll be worth £400,000 so that’s plausible.

If everything makes sense, they will be happy to offer you a facility for development finance.

What if I have bad credit? Can I still get development finance?

Yes. It doesn’t matter with development finance if you’ve got bad credit or you’ve had some issues in the past. Development finance is what we call asset finance, so ultimately lending decisions are based on the strength of the underlying asset and the work you’re anticipating, as evidenced through the schedule of work, costs, and the value of the asset post-works.

Even if you’ve got pretty bad credit, as long as the asset’s good, the work you’re doing is plausible, and the final value is as anticipated in the open market, lenders are more than happy to lend on a development funding basis.

What else do we need to know about development finance?

Just so people understand if they’re new to development finance, there are usually two parts to it. If you’re looking to buy a property to refurbish or redevelop, the first part of the funding will be to purchase the asset you’re going to develop.

That money is released and you take ownership of the property. Then the development funding is usually released in tranches. Say you have a facility for £100,000 – the development funder might release that in four tranches of £25,000 as you reach each stage of the development.

As you get towards the end of the project, the final tranche of money will be released and you will complete it. The good thing is that you only pay interest when you draw the money down. So even if you have a £100,000 facility and your first tranche of money is £25,000, you’re only paying interest on the £25,000.

If in the end you don’t need the full amount of £100,000, just £75,000, you would only pay interest on £75,000. You’re not paying interest on that money until you draw it down.

Some Bridging Finance is not regulated by the Financial Conduct Authority.

YOUR PROPERTY MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.

Most Buy to Let mortgages are not regulated by the Financial Conduct Authority.

Approved by The Openwork Partnership on 16/08/24.

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