It is used by property developers, investors, and landlords who want to undertake large-scale building or renovation works. In this article, we will explain how property development finance works, what are the pros and cons of using it, and how to apply for it.

What is property development finance?

Property development finance is a form of advanced loan that allows developers and builders to raise funds towards the purchase price of property (or land), as well as providing the necessary development costs for converting or refurbishing it. Unlike traditional loans, property development finance works by taking the value of the property on completion into consideration – with the expectation being that the value of the building will have increased by the end of the financing period. This enables builders and investors the opportunity to undertake high-profit schemes that would usually be out of reach and budget, whilst receiving a greater return on their investment.

Property development finance is a fairly broad category that covers term loans, mortgages, bridging loans and even personal loans. It refers to the large-scale funding of significant building or renovation works. You might use it to fund a new residential housing project, workspace development or regeneration initiative. Development finance is likely the most appropriate form of property finance for ground-up developments, such as building a property from scratch.

Funding a Property Development Project.

 If the borrowing requirement is between £750,000 to £30,000,000 and typically for a period between 12 and 30 months for a ground-up residential development of 6 or more units or a large-scale commercial to residential conversion then traditional property development finance will be required. This type of loan is specifically designed for larger and more complex projects, with longer repayment terms and more stringent eligibility criteria.

Or, on the other hand, if the borrowing requirement is between £50,000 to around £2,000,000 for a single unit buy-to-flip refurbishment property, a bridge to-let project, an auction property purchase, a commercial to residential conversion or a small new build development of up to 6 units then a development bridging loan can be tailored to meet the specific needs of each project.

In certain situations, developers can borrow up to 100% of the property or land purchase price with the development costs drawn down in tranches.

Bridging and Development finance lenders will assess the viability of the project and the borrower's experience in executing the project.

This includes evaluating the property's potential for development and the borrower's proposed exit route and will assess the borrowing capacity for a development project based on the GDV (Gross Development Value) of a project and apply the LTGDV (Loan to Gross Development Value) calculation to establish the maximum loan amount that would be available.

Both types of lenders will advance a percentage of the land or property purchase price or value on Day 1 then provide a drawdown facility that can be drawn every month for the build costs or refurbishment costs.

With the right documentation and a solid development appraisal, developers can secure the necessary funds to bring their projects to life.

How does property development finance work?

Property development finance works by being issued in set stages in line with the development project(s). Development finance loans work by having funds paid out to you in drawdown stages as your property development project progresses, known as ‘tranche drawdowns’. In most cases, lenders will carry out periodic re-inspections of the site before each payment is made, similar to a self-build mortgage.

The amount of money you can borrow depends on the type of project, the expected gross development value (GDV), and the loan-to-value (LTV) or loan-to-cost (LTC) ratio. The GDV is the estimated value of the property once the development is completed, while the LTV is the percentage of the GDV that the lender is willing to lend. The LTC is the percentage of the total cost of the project that the lender is willing to lend. Typically, lenders will offer up to 70% of the GDV or up to 90% of the LTC, whichever is lower.

The interest rate and fees for property development finance vary depending on the lender, the project, and the borrower. Generally, the interest rate is higher than a standard mortgage, ranging from 6% to 18% per annum. The interest can be paid monthly, rolled up and paid at the end of the loan, or deducted from the loan amount at the outset. The fees may include arrangement fees, exit fees, valuation fees, legal fees, and broker fees.

The duration of property development finance is usually between 6 and 24 months, depending on the scale and complexity of the project. The loan is repaid either by selling the property or by refinancing it with a long-term mortgage.

What are the pros and cons of property development finance?

Property development finance has many advantages over other forms of finance, such as:

  • It provides the opportunity to take on larger projects with a better return on investment (ROI).
  • It is appealing to borrowers who require funds to increase the value of a property.
  • It offers a quick way to raise capital, with funds being made available in a matter of days.
  • It is short-term and doesn’t require a substantial proportion of cash to be tied down for years to come.
  • It covers both the purchasing cost of a property as well as contractors and materials.
  • It allows developers to undertake multiple projects simultaneously, without waiting for an existing project to complete.

How to apply for property development finance?

If you are interested in applying for property development finance, you will need to prepare a detailed business plan and feasibility study for your project. This should include:

  • A description of the property, its location, and its current and future use.
  • A breakdown of the purchase price, the development costs, and the expected sale price or rental income.
  • A timeline of the project, including the planning permission, the construction phases, and the completion date.
  • A cash flow forecast, showing the income and expenses of the project, and the repayment strategy.
  • A risk analysis, identifying the potential challenges and mitigating factors of the project.
  • A portfolio of your previous development projects, demonstrating your experience and track record.

Obtaining property development finance can be complex, once you have gathered all the necessary information and documents, you can approach an experienced commercial finance broker who specialises in property development finance to assess your project and guide you through the process.

Conclusion

Property development finance is a useful tool for property developers, investors, and landlords who want to undertake large-scale building or renovation works. It works by providing funds in stages, based on the value of the property on completion. It has many benefits, such as allowing you to take on bigger and more profitable projects, but also some drawbacks, such as being more complex, risky, and expensive than other forms of finance.