How Does Development Finance Work?
The Development finance availably will usually be based upon the final Gross Development Value (GDV). This equates to the money loaned relating to the site’s worth when payments for the refurbishment or construction work are complete.
Typically we see clients borrow 60%/65% of the purchase price and then can borrow up to 70%/75% of the end GDV.
The finance is drawn down in stages, also known as tranches, and these are paid after each stage has been completed and signed off by a qualified surveyor (QS). Typically the quantity surveyor will visit the site, see the work that has been done, see the materials on the site and invoices paid, confirm the works and sign off to the lender to release the next stage of funding. This typically takes around a week to process, so really should not hold up the development.
Once the development is completed or properties within the development are complete, the finance is paid off usually by either re-financing or the sale of properties within the development.
How Do You Get Development Finance?
Development finance doesn’t work the same way a traditional mortgage works. With this finance style, lenders assess the predicted value of the property when the project is complete, along with the current value, cost and estimated time of the development
Applying for development finance involves submitting an application to the lender which will detail:
- Full development cost including all utilities, any CIL payment to the local authority, contingency (typically 10%) and professional fees involved.
- Gross Development value (GDV) – i.e. what the site will be worth once completed.
- Exit Strategy – how will the finance be paid off, for example, sale of properties or refinance.
- The timescale for the project – This is to develop the site and allow a suitable timeframe for the properties to be sold or refinanced.
- CV of experience of the borrower, or where they don’t have experience – the experience of the main contractor involved.
A lender will then provide a list of requirements & documents for the borrower, and the lender will also carry out a credit check on shareholders who own 25% or more of the company.
Development finance is funding that finance brokers can access through specialist banks and specialist lenders. This type of finance is typically made to experienced developers who have a previous track record. A handful of lenders will consider inexperienced or first-time developers, but usually, this is conditional on the borrower working with an experienced builder/contractor/ project manager. As part of any development loan application process, a lender will look at the location, planning approval, and comparable properties in the area.
If you are unable to raise the full amount of borrowing needed from the main lender, another form of finance to help with developments is Mezzanine Finance – which could provide the additional finance needed to get the project started. Most development lenders have relationships in place with Mezzanine finance companies, who they have previously worked with, so this is a good starting point.
Useful Videos About Development Finance
Prefer to watch rather than read? Our short videos walk through the key points of development finance, from how the funding is drawn down to what lenders look for in an application.
Should Use a Development Finance Broker?
While using a broker is a sensible step with any form of loan or mortgage, it is indispensable for development finance. Many lenders will only provide development finance through a broker, so anyone looking to enhance their arranging finance chances needs to take this approach. Development finance lenders will carry out a lot of due-diligence on the transaction and these deals are bespoke, so using an experienced development finance broker is essential.
It is common for development finance to be issued to experienced developers who can point to a proven track record in these projects especially for larger scale projects £1m+.
Advantages and Disadvantages of Arranging Development Finance
Some of the leading advantages of arranging development finance include:
- This finance allows developers to take on larger projects, which should yield larger profits.
- Developers can retain capital and use this in other areas or projects rather than having all their money tied up in one development.
- Developers risk less of their own money.
- This support enhances a business’s cash flow.
Some disadvantages would include:
- Development finance is more expensive when compared to traditional mortgages, but unfortunately mortgages will simply not lend on this type of transaction, although if you were building your own home, you should explore self build mortgages, which would be cheaper when compared to development finance.
- If a project overruns it will add more cost, so you need to factor in contingencies.
Associated Costs with Development Finance?
There can be many costs involved, so it is really important that you are full aware of them all to make sure the project is profitable. Costs would include:
- Lender arrangement fee – This can range from 1% to 2% and is typically built into the loan.
- Valuation Fees – This would be an upfront cost and is dependent upon the project
- Legal Fees for both you and the lender. Make sure you have a really experienced commercial solicitor in place as these transactions can be really quioe complex
- Quantity Surveyor / Monitoring Surveyor – There will be an upfront cost for them to visit the site to confirm the viability of the scheme and also a cost to visit the site upon each stage drawdown. The lender may also charge an administration fee of each drawdown.
- Broker Fees – Best to confirm how much and when payable as many brokers have different fee structures.
- CIL Payment – Payable to the local authority typically within 60 days of the development starting.
- Stamp duty – if you are purchasing the land / site.
- Warranty
There maybe other costs, so make sure you get a full breakdown before committing.