In the last few years, property development finance in the UK has started to evolve. However it can be difficult to stay on top of all the changing elements, especially if you are not speaking to every possible lender that there is and comparing like for like simultaneously.
We will go through the key elements that make up a development loan today, so property developers, aspiring developers and associated professionals can be on top of this from the start.
1 Pre-approval: Loan to Value (LTV) and Gross Development Value (GDV)
As most of us know, typical property lending is calculated as a percentage of the value of the property (the valuation given can be today’s Open Market Value, or a reduced value should the property need to be sold within 90 or 180 days of purchase in a repossession situation). The percentage is usually lower than 80% because in a repossessed situation (everyone’s worst case scenario), a property will sell for less than market value, and a lender needs room to get their money back.
Development lending is different, where funding is calculated against the future value of the site once the properties have been built, rather than just the current value of the land. Funders will lend anything up to 75% of the final value of the site, although the standard is 60%-65% of GDV.
Usually funding is phased as a stable percentage as the value of the site increases during building. If the land needs to be purchased, the funder will usually require some form of cash input from the developer, which is typically between 25% and 50% of the site purchase price. It is normal now to get 100% of the build costs funded. Larger developments can also get funded quoted as a percentage of the total cost, where some form of equity stake may also need to go in from the borrower or interested third party.
2 Pre-approval: Loan to Cost (LTC)
Funders also use the Loan to Cost ratio, which states what percentage of the total project costs they are willing to lend. LTC percentages are anywhere from 75% up to as much as 95%. So in a standard 30-30-30 scenario where the land costs £1m, the build £1m, and the profit £1m (£3m GDV), the total costs are c.£2m and on a 90% loan to cost ratio, the funder will lend up to £1.8m, with £200k needed from the developer (which happens to be 60% of GDV as well). This typically goes in on day one.
The LTC percentage is much higher than the GDV percentage because a higher GDV percentage would impact substantially on profit margins. Even at 75% of GDV, that leaves only 25% gross for the developer before the project starts. Higher LTC ratios are in place because most funders appreciate many developers are not cash rich, and struggle with larger deposits.
3 The process timeline
Development funding follows a virtually identical process to any other property transaction. Once funding is provisionally approved at credit committee stage, there is a valuation and legal process is order to confirm the security’s value and ownership. Once both aspects are confirmed, the funding can be confirmed and the lender registers a charge on the security with the Land Registry. 2-4 weeks is a standard timeframe, although the process can be considerably longer when the borrower’s solicitors are not working in time with everyone else.
4 The Money Flow
Funders do not give the funds to the developer as such. The developer assigns the work to be done, typically on a monthly basis, and an appointed monitoring surveyor comes round to confirm the work stated has being done. From there, the funder will pay the builders/contractors direct for the works undertaken.
5 Interest: Why an advertised Monthly Rate is often not the real Rate
Interest rates differ between lenders who charge an annualised rate, or a monthly rate. In the case of rates being charged on a monthly basis, it is not correct that you get the annual rate by multiplying x 12! Some funders’ monthly rate is charged on the total facility amount, which means that monthly rate can be multiplied by 12. However, there are many other funders whose monthly rate is charged only on what you have drawn down and spent so far (like a credit card). In the second instance, the annualised rate ends up being much lower when drawdowns are spaced and total interest is essentially not charged on the full loan amount until the final draw down towards the end has been completed.
6 Facility Fees: how they actually work
Equally some funders advertise a very low monthly rate but charge very high arrangement and exit fees to make back on what they lose upfront. In most normal cases, standard arrangement fees are around 1-2% of the facility and exit fees around 1-3% of the facility. In some cases the interest rate appears to be much higher but there are no exit fees for instance.
It is vitally important that when evaluating an array of funders, you put together a cost comparison spreadsheet so you can see clearly what the true cost of funding really is. This needs to be a highly detailed spreadsheet showing finance costs at every stage of the development, including all fees from start to finish. Only then can the true cost of funding be compared. Otherwise it is impossible to know if you have selected the cheapest offer or not.
7 Phased building: how it drastically lowers finance costs
Phasing a development, rather than building in one go, can be financially advantageous. For a start the funding required at any time is much lower, and so are the fees as a result. By phasing, a developer also lowers the annualised rate as less is being drawn down earlier, as previously discussed. A lower facility amount also means you’re more likely to approved for funding, especially if the numbers are close, or even over criteria.
Still need more funding?
Many projects, whilst getting approved for 1st charge debt funding, are still short of total funds needed to build out and sell. Some developers simply don’t have the rest of the funds needed to either buy or fund part of the development. 2nd charge lending, also known as mezzanine funding, is there to help, as well as private equity investors for the deposit. Both these routes are more expensive, but if there is no other way, at least avenues exist to move forward.
Those are the key elements when assessing development finance facilities. With a lack of any sort of development funding comparison service, the most important next action is to know who to talk to, and how to compare the different options. Hopefully this article has at least helped with the latter.
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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.