MoneyMagpie

Jul 18

A Guide to development finance

Development finance is a type of specialist finance used for developing a property, specifically renovations and refurbishments. It is commonly seen as an alternative to applying for a mortgage, whereby property developers and investors are able to get access to finance quicker and with more flexible terms.

This source of finance is popular for those who are looking to restore or renovate a new build or existing property with the purpose to re-sell it at a higher price on the open-market or rent it out to tenants.

The loans tend to last 3 to 24 months and range from £50,000 to £250 million. They are secured on the estate so the borrower has a risk of their property being repossessed if they cannot keep up with repayments.

 

Why Use Finance Instead of a Mortgage?

 Development finance is a practical way to “break the property chain” and the lengthy process you would usually associate with a mortgage application.

If the investor has a deadline for a property, they may be able to get the finance they need from a specialist lender like Aldermore or Regentsmead in around 2 weeks, rather than having to wait several weeks for a mortgage to go through.

In the same way as a mortgage, development loans can be used for residential, commercial and new build properties. So this is useful for those looking to build an estate and rent it out to tenants, either individuals or shop owners.

 

How Much Can You Borrow?

The amount you can borrow through development finance is based on the gross development value (GDV), which is what the property will be worth when all renovations have been completed and it is ready for sale. The costs are broken down into two parts, construction and land costs.

The construction costs refer to all the physical building work required, electricals, materials, building work and plumbing too, whereas the land costs refers to purchasing the plot of land itself. Typically, development lenders can allow you to borrow up to 100% of the build costs (including new builds) and then up to 75% of the value of the land.

 

Development Finance Example

 A developer has planning permission to build three houses with the gross development value estimated at £10 million. The total costs involved are £5 million, made up of £2.5 million for purchasing the land and £2.5 million in build costs. A lender might agree to development finance of £7.5 million (limited to 75% of costs) structured as £1,000,000 initial advance followed by the balance in stages throughout the build.

 

What Are The Fees Involved?

Development finance companies charge rates of interest and do not receive any equity in the property that they are selling. For a combination of equity and debt, this is known as ‘mezzanine finance’ and is commonly used for individuals with riskier credit profiles and could be the only option for them to get the finance they need.

Interest rates start at 6.0% per annum, although this will vary from lender-to-lender and other factors such as loan-to-value, security, credit history and affordability. Additional fees are involved when buying and building a property such as broker fees (2%), commitment fees (2%), valuation fees, solicitor fees and stamp duty.

The rate is clearly more expensive than the standard variable rate of your average mortgage, at around 2%. The excess that you are paying is for the speed of the transaction, the ability to receive funds in stages and also the expertise from the development lender to guide you.

 

How is it Different to Bridging?

Very close to development finance is bridging finance, which is used to complete on a loan where there is a strict deadline and a mortgage would otherwise take too long.

To distinguish between development and bridging, it is common to look at how ‘heavy’ the renovation is. Where bridging is used for purchasing the property, development finance is better suited to making renovations such as light refurbishments, rebuilding or starting a new property from scratch.

 

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