How Does Property Development Finance Work

Ever wondered how property developers manage to fund multi-million pound projects? The answer often lies in property development finance.

Let's unpack how it works and why it might be perfect for your next development.

The property market continues to offer exciting opportunities for developers, with demand for new homes and commercial spaces remaining strong.

For many developers, however, securing the necessary funds to bring their projects to life can be a significant challenge.

This is where property development finance comes into play.

Property development finance is a specialised form of lending designed to support the construction, renovation, or conversion of residential and commercial properties.

Unlike traditional mortgages, which are based on existing property values, development finance considers the potential value of a completed project.

This guide will walk you through the ins and outs of property development finance in the UK, helping you understand how it works and whether it’s the right choice for your next project.

Understanding Property Development Finance

At its core, property development finance is a short-term loan tailored to the unique needs of property developers. Its purpose is to help fund the renovation and construction, and many lenders are also willing to provide funding to purchase the initial asset.

It differs from standard mortgages in several key ways:

Development finance is offered for short periods ranging from 6 to 24 months, aligning with the timelines of most construction projects.

The loan amount is based not just on the current value of the land or property, but on its projected value upon completion. This allows developers to access larger sums of money, often up to 70-75% of the gross development value (GDV).

The funds are released in stages as the project progresses, rather than in a single lump sum. This staged approach, known as drawdowns, helps manage risk for both the lender and the borrower.

Interest rates for development finance are higher than standard long-term mortgages, reflecting the increased risk involved.

Types of Property Development Finance

There are several types of development finance, each suited to different project scales and complexities:

Ground-up Development Finance

This is used for new-build projects starting from bare land.

It covers both the purchase of the site and the construction costs. For example, a developer planning to build a block of flats in Manchester might use this type of finance to fund the entire project from land acquisition to completion.

explore ground-up development finance

Heavy Refurbishment Loans

These are ideal for major renovation projects that involve significant structural changes. A developer converting a large Victorian house in London into luxury apartments might opt for this type of finance.

Light Refurbishment Loans

Light refurbishment loans cover works that don’t require planning permission or building regulations approval, such as redecorating, updating kitchens and bathrooms, or replacing fixtures and fittings.

With terms usually ranging from 6 to 18 months, light refurbishment loans offer a flexible funding solution for developers aiming to quickly add value to a property before selling or refinancing.

Refurbishment Finance

Conversion Finance

This is used when changing the use of a property, such as turning an office building into residential units. A project transforming a former warehouse in Birmingham into a mixed-use development with shops and apartments would typically use this form of finance.

Financing a Commercial to Residential Conversion

How Property Development Finance Works

Securing development finance begins with a thorough application process.

Lenders will require a comprehensive package of information, including:

  • A detailed business plan outlining the project scope, timelines, and projected costs and returns
  • Evidence of planning permission and architectural plans
  • A breakdown of construction costs
  • Proof of the developer’s experience and track record
  • Details of the proposed exit strategy (how the loan will be repaid)

All lenders place significant emphasis on the developer’s experience.

While some will consider first-time developers, most prefer to work with individuals or companies that have a proven track record of successful projects.

The application is then assessed based on several factors, including the viability of the project, the developer’s creditworthiness, and the strength of the exit strategy. This process can take anywhere from a few weeks to several months, depending on the complexity of the project and the lender’s requirements.

Loan Structure and Drawdowns

Once approved, the loan is structured in two main parts:

Site purchase

An initial sum is released to cover the land purchase or existing property acquisition.

Building costs

The second part of the loan is used to pay for the build works and construction costs. The agreed amount is handed over in stages, according to how the project is progressing.

The staged release of funds, or drawdowns, is a key feature of development finance.

A typical drawdown schedule might look like this:

  1. Initial release: 10% of loan value upon exchange of contracts
  2. First stage release: 25% upon completion of foundations
  3. Second stage release: 25% when the property is wind and watertight
  4. Third stage release: 25% upon completion of first fix and plastering
  5. Final release: 15% upon practical completion

Before each drawdown, the lender will usually require a visit from a monitoring surveyor to verify that the work has been completed to the agreed standard and that the project is on track.

Interest and Repayment

Interest on development finance is charged in one of three ways:

  1. Rolled up: Interest is added to the loan balance and paid at the end of the term
  2. Serviced: Monthly interest payments are made throughout the loan term
  3. Retained: Interest is deducted from the loan amount at the outset

The choice of interest payment method can significantly impact cash flow during the project, so it’s important to consider this carefully. Most lenders will be amenable to either a rolled up or retained option, preserving your cash flow.

Repayment of the loan usually occurs either through the sale of the completed development or by refinancing onto a longer-term mortgage product. The exit strategy is a critical component of the initial application and will be closely scrutinised by the lender.

In a situation where the development will overrun its loan deadline, you should first approach the lender and ask for an extension. If this is not possible, ask your broker to investigate development exit finance. This replaces the initial development loan, giving you more time to finish the project.

explore Development Exit Finance

Let’s talk development finance!

Book your free consultation today and let’s discuss how we can help you achieve your property goals.

Key Metrics in Property Development Finance

Understanding the key financial metrics used in development finance is essential for any borrower. These metrics help lenders assess risk and determine how much they’re willing to lend:

Loan to Gross Development Value (LTGDV)

LTGDV is the ratio of the loan amount to the expected value of the completed development. It’s calculated as:

LTGDV = (Loan Amount / Gross Development Value) x 100

LTGDV ratios typically range from 60% to 75%. For instance, if a project has a GDV of £5 million, a lender offering 70% LTGDV would be willing to lend up to £3.5 million.

Related: Loan to Gross Development Value: What is LTGDV?

Loan to Cost (LTC)

LTC represents the ratio of the loan amount to the total project costs. It’s calculated as:

LTC = (Loan Amount / Total Project Cost) x 100

LTC ratios in the UK often range from 70% to 90%. Using our previous example, if the total project cost is £4 million, a lender offering 80% LTC would provide up to £3.2 million.

Day One Land Leverage

This metric refers to the percentage of the land purchase price that the lender is willing to finance upfront. It’s typically lower than the overall LTC, often around 50-65% of the land value.

For example, if a plot of land costs £1 million, a lender offering 60% day one land leverage would provide £600,000 towards the purchase, with the developer funding the remainder.

Costs and Fees

While interest rates are a significant cost in development finance, there are several other fees to consider:

Arrangement Fees: These are around 2% of the loan amount and cover the lender’s costs in setting up the loan.

Exit Fees: Some lenders charge an exit fee when the loan is repaid, usually around 1-2% of the loan amount.

Valuation and Monitoring Surveyor Fees: These cover the cost of initial property valuation and ongoing project monitoring. They can range from a few thousand pounds for smaller projects to tens of thousands for larger developments.

Legal Fees: These can vary widely depending on the complexity of the project and the loan structure.

VAT: Many commercial acquisitions will have VAT added to the agreed purchase price. This adds 20% to your initial outlay, which won’t be covered by any development finance. Consider looking at a VAT bridging loan, which will lend the VAT element, until your HMRC refund comes through.

Securing Property Development Finance: Tips for Success

If you’re looking to secure development finance for your next project, consider these tips:

Build a Strong Track Record

Lenders favour experienced developers. If you’re new to development, consider partnering with a more experienced developer or starting with smaller projects to build your credentials.

Develop a Comprehensive Business Plan

Your business plan should include detailed cost breakdowns, realistic timelines, and thorough market analysis. The more comprehensive and well-researched your plan, the more confidence lenders will have in your project.

Understand Lender Criteria

Different lenders have different appetites for risk and preferred project types. Research potential lenders thoroughly to find those that align with your project’s characteristics.

Work with a Specialist Broker

A broker with expertise in development finance can help you find the best deals and negotiate favourable terms. They will be able to present your application in the best possible way and give you access to more than 200 lenders.

Have a Clear Exit Strategy

Whether it’s sales or refinancing, your exit strategy should be well-defined and backed by market research and contingency plans.

Related reading: Exit Strategies for Property Developers

Is Property Development Finance Right for Your Project?

Property development finance can bring your development projects to life, offering access to substantial funding based on the potential of your project rather than just its current value.

However, it’s not without its challenges and risks.

When considering development finance, ask yourself:

  • Do you have the experience and expertise to manage a development project successfully?
  • Is your project viable, with a clear path to profitability?
  • Can you comfortably meet the interest rates and fees associated with development finance?
  • Do you have a solid exit strategy and contingency plans in place?

If you can answer yes to these questions, development finance could be an excellent option for your project.

However, given the complexities involved, it’s always advisable to seek professional advice before proceeding. A specialist finance broker can help you explore the options and find the best solution for your specific circumstances.

Remember, successful property development is as much about smart financing as it is about good design and construction.

With the right approach to development finance, you can turn your property development ambitions into reality, contributing to the UK’s evolving urban landscape while potentially reaping significant financial rewards.

Need some help?

If you need a bridging loan or development finance then a specialist broker is a good place to start. You will get expert help and advice along with a wide range of lenders to choose from.

To get matched with a specialist broker, please call us on 0330 030 5050.

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