Land and Property developers have had a tough time of it since 2008. One of the biggest business problems has been the availability of funding to a) move stalled projects, b) start new ones or c)take advantage of new opportunities quickly.
The good news is there are some interesting finance products emerging in the marketplace. Understanding what the finance market offers and locating hard-to-find development finance products is one of the biggest challenges facing developers.
Over the last 12 months or so, capital has come back into development funding in a number of guises, and this article’s purpose is to get investors, landowners and developers up to speed with the top-level facts of development finance in the UK today, and what the market is now offering.
Facts about development funding today
The general consensus is that due to the lack of bank funding, developers cannot get on with projects, nor take advantage of opportunities that quickly come their way. I would argue that this is not the case, if you’re armed with the correct information. Below is information about development funding that should be helpful:
Most development finance products are not mass advertised
In the boom times, it was obvious who to go to; the banks. Whilst they still have an offering (discussed later on in this article), a growing number of new players are entering the marketplace. Backed by either institutional money or funds from High Net Worth Investors, a good number of products exist.
However, the bad news is that they tend not be advertised that well, nor publicise themselves in the Press. There are two ways round this. Either spend a lot of time yourself searching the internet, going to trade shows and developing contacts over a significant period of time, or you can save time by accessing these contacts quickly through a non-fee charging commercial finance specialist.
London is where most funding wants to be placed
Let’s get the rest of the bad news out of the way first! Whilst there are substantial funds coming into the development finance sector, much of it wants to be placed in London. This is for the well-known reason that end units are more likely to sell or rent out, and the asset value is likely to increase in value. As a result, development finance products tend to be more flexible than in other parts of the country.
However, this does not mean that funding is not available if your project is outside London! What it does mean is that for non-London projects, there is a more intense focus on the risks of the project, the realistic sale prices/rental values, and the reality of selling out in general.
There still exists a gap in rates, bar 2 products
The gap between bank funding and the more expensive bridging finance products by and large still exists. However, there are a couple of product types that provide a realistic APR at around 10% p.a. Lets first take a look at the two ends of the lending spectrum and what they offer:
Banks are lending but on a conservative basis.
Rates are from 4% over base, capital and repayment only, and for up to 20 years. However, you will need a solid track record, and cash in the bank (typically 10%+). Banks do not consider owned land or sunk costs as cash in the bank/developer equity, which is why many developers, who effectively ceased trading and sat on their land in the recession, cannot get bank funding.
Bridging finance is at the other end of the spectrum, where lending can be against the future value of the site, and come in as low as 10% APR, if you know where to look.
The significant benefit of this finance is funds lent can be against the future value of the site on completion (know as the Gross Development Value, or GDV), rather than the value of the site as is now. This gives far more leeway to access higher levels of capital. 50-55% GDV is where the market currently sits.
Rates are harder to understand because different lenders charge different fees at different stages, plus the advertised APR is not as straight forward as it looks. Just going with a lender who has the cheapest advertised APR does not mean you get the cheapest deal! I’ll explain…
Rates for most development projects UK wide tend to be around 1.5% per month, which most prospective borrowers take as meaning an APR of 18% per annum. However, with certain products, the rate can be as low as 10% APR.
The way to understand the true cost of funding is twofold:
1. Most importantly, understand if the interest rate is charged on the whole facility (regardless of how much of the funds are used) or only on the amount drawdown so far.
If your firm is drawing down funds in equal monthly instalments, it is more cost effective to go with a lender that only charges interest on the cumulative drawdown amount each month. The facility operates like a credit card. You pay interest on what you have used, not what your credit limit is. In this example, it is not uncommon for the true APR over 6-9 months to be around the 10% mark.
2. Add all the fees being charged together with the likely period of total interest
So add any upfront fees, admin fees, arrangement fees, early redemption fees, and exit fees together. All lenders vary in terms of their fee structure, so it is important to understand all the fees together to get a true picture. If you are going to borrow for 6 months, conservatively aim for 9 months @ 1.5% per month and add this total to the total fees.
So what are the two products that provide a rate in between the two?
The second product is for £1m+ developments, mainly in London, which is around 7-8% per annum. This product again requires a minimum 10% equity, and a strong track record. Interest is charged on the drawdown amount, with interest rolled up for 14-20 months, compounded quarterly.
Other insights into development funding
1. It is possible to fund 100% of the purchase and development costs but you must have other unencumbered property to assign a 1st legal charge on, at a level that provides comfort to the lender.
Otherwise, you will be required to put something into the deal, such as:
You already own the site
You have funds available to put into the deal at some stage
2. If a bank has pulled funding halfway through, it is entirely possible to fund the remainder of the project.
3. It is entirely possible to fund the purchase of sites that have planning potential. Permitted Development Rights, with the specific focus on changing offices into residential property, have enabled developers to look for existing sites which don’t need as much costing, whilst also allowing them to get the change of use quickly without a full planning application. The Government's planning portal has significant information on this exciting opportunity, and a future article will focus solely on this new sector.
In summary then, more cost effective avenues are opening up for developers and related investors, and it is possible to find the right funders without wasting lots of time trying to find them.
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About Chris Davidson
Chris Davidson is Managing Director of Discover & Invest Ltd.
He believes passionately in providing businesses with market-leading financial insights that have a positive impact on the bottom line. As a result, Chris helps get the best rates and terms available at any one time.