Property developing is a wide and exciting sphere of progress. It’s an industry that will never die out; people are always going to need somewhere to live, there will always be houses to be renovated, housing developments to be built, flats to be refurbished and the rental market is ever-expanding. So it’s understandable why so many people want to dip their toes in the world of property development.
If it’s approached determinedly, logically and carefully, there is potential for making quite a bit of return on your investments. The key to this is a thorough understanding of the property market, a robust and comprehensive business plan detailing your project in-depth and being able to secure the right finance deal to bring your plans to fruition. Property finance is one of the more complicated areas so it’s important to start at the very beginning to give you the best idea of success.
As the name suggests, development finance is there to fund the development and/or conversion of buildings. Examples include:
- Building a new development on a site
- Building a new property on an existing site
- Refurbishing a property to get it ready for sale or to rent
- Complete renovation of a property to get it ready for sale or to rent
For a more comprehensive view – read The Development Finance Guide on Brickflow.com
And you can also plan to combine any of the above.
The finance is for a short term only, it’s there to fund the initial purchase of the property if necessary and then for the remainder of the building works until they are completed. The loan is only whilst the actual building process itself is going on. The loan is then repaid at the end of its term, either through the sale or rental of the property or through re-finance. A loan of this nature is only a good idea in the short term because the interest rates can be punishingly high. A mortgage is a better idea for funding long term debt because the interest rates are lower and therefore your profit is higher.
The loan itself will be secured against the property and/or development site, like a traditional mortgage on a residential house. Apart from the initial sum, the loan will be paid in stages as the building work progresses, unlike a mortgage which is paid upfront in its entirety.
You can elect to request an advance from the lender as an initial sum before the building work itself actually starts. There are multiple reasons for doing so: perhaps to repay outstanding loans already taken out, to begin the construction itself or to purchase the site. As a rough figure, 65% of the agreed sum can be released on Day 1. There are circumstances where lenders will be happy to advance the full sum but these would be tailored to individual circumstances. It’s better to play safe and assume one upfront sum and then monthly payments after that.
In order to approve the drawdown payments there will be a monitoring surveyor on site who will inspect the building works, look for any faults and ensure that everything is progressing within the agreed timeframes. Once approved, the next instalment will be paid. The loan becomes repayable once the building works are completed.
A bonus of funding your project this way is that because the loan is paid in stages, it effectively carries the interest itself for the initial loan term. This is beneficial in several ways, not least because cash flow can be a tricky thing to manage during the build. This is similar to how bridging loans work.
Development rates and charges
There are a number of factors which determine the risk to the lender and therefore the rates applied, such as the type of project being undertaken and things like the location. Lenders will often prefer certain more desirable areas for the development and be less keen to fund the development in less salubrious areas.
- Loans with higher gross development value are typically preferred by lenders as opposed to smaller schemes, so that’s a good starting point for securing a good finance package. Additionally, if the developer has previously completed similar projects successfully then that’s also a helping hand. A popular developer will be someone with previous proven success and a strong profile. Someone like this will have much more control over what rates they are given.
- The amount of the loan requested also plays a part. Counter-intuitively, if the amount is lower then the rates are higher, the reason being that a smaller loan is just as much work to sort out as a larger loan and the lender will be looking to protect their profits.
- Economies of scale also feature heavily in virtually all areas of property development.
But if you are a novice then all is not lost, you will just have to work exponentially harder to get what you want. If this is the case then to secure what you want you need to have:
- Comprehensive and robust business plan covering every angle of your proposed development.
- Detailed drawings from a reputable architect.
- Confirmation of planning permission if needed.
- To have scoped out your intended development properly and thoroughly.
All of these help to reduce the risk so lenders will be more inclined to invest their funds.
Advantages and disadvantages
There are a mixture of these when it comes to property financing. All developments are different of course and must be treated as such. It’s imperative to weigh up the pros and cons before making a final decision.
The plus points of taking out finance:
- You can complete much larger projects. Finance allows you to expand your development and therefore make a much higher profit.
- If you keep hold of your capital then you can invest elsewhere and increase your profit exponentially.
- Having 2-3 developments in progress rather than one spreads the risk of investment.
- The return on investment (ROI) will be increased. The cash outlay will be diminished and the cost of the finance will only have a small effect on the profit total and therefore the profit made per £ spent will be higher.
- Taking out finance for your funding will also have a positive impact on the notoriously tricky cash flow situation during the build. It will help you avoid the typical position of a developer – being asset rich and cash poor. By using finance you can keep your larger cash reserves which might be useful during the build.
- There’s less risk to your personal money.
The minus points
- Securing finance involves a long application process. There’s a lot of information to be gathered together and lots of hoops to jump through. Once approved, there will be multiple on site inspections and face to face meetings during the build which can be time consuming, especially if this is not your day to day job. If you’re not keen on dealing with all this by yourself, then by using a decent broker you can remove much of the stress from the process.
- On a similar note, lenders or their representatives will want to visit the site frequently. The drawdown payments can only be released once the monitoring surveyor has confirmed that everything is progressing as it should. This can also be stressful and time-consuming.
Ultimately, you will just have to do your research and decide for yourself what the best method of finance is going to be. As Benjamin Franklin once said: “By failing to prepare, you are preparing to fail.”