Development Finance – FAQ’s
Below we have provided up to date information on the Property Development Finance market in Q&A format, which we trust will be of use to both experienced developers and those starting on the ladder.
How would you describe the residential property Development Finance market at the moment in terms of both demand for and supply of finance?
After the doldrums of 2008/11 demand for quality housing is strong and with the improved availability of mortgages (augmented by the Government’s First Buy and Help to Buy schemes) this is fuelling demand and price increases. Not surprisingly therefore there is an increased demand for finance from property developers.
On the supply side the market is improving month by month and we are seeing both the return of former lenders and new entrants into the market and a return to the more highly leveraged structures of the pre credit crunch days. There is a dearth of 100% funding models; there are a few structures for experienced developers with well-located and profitable projects but lenders-investors want their pound of flesh. There is a wider pool of available equity, to sit behind debt and take leverage up to 100% LTC, if the developer is able to contribute a few per cent of costs as hurt money.
There is also a much improved supply of long term investment finance for residential property portfolios, thus enabling developers to retain units for investment and access funding to repay the development lender. In turn this improved market for term investment funding is giving short term development lenders confidence to lend in the knowledge that they may be repaid from either sale or refinance.
Is property Development Finance available throughout the UK?
Funding is available in England, Wales and Scotland for well-designed and located housing and flatted schemes where demand for the units is proven. There is, however, very little appetite for Northern Ireland. There are far more options for projects located in London, the South East and other hot spots than in some parts of the UK where sourcing funding, particularly for larger schemes is challenging.
Will lenders finance a residential scheme where there is an element of commercial space included; such as a block of flats above a row of shops?
Yes many lenders will consider such schemes but generally do not like to see more than c. 20% of the Gross Development Value (GDV) being commercial space. However it will also depend upon location and demand and the lender will ask the valuer to comment.
What types of institutions are lending?
Investment banks, challenger banks, specialist property funds, peer to peer platforms, family offices, bridging lenders; all of whom have expanded their markets and moved into traditional high street bank space.
What about the high street banks?
If we accept there are five main high street banks, in theory three of them will lend on property developments projects. However the applicant must have significant experience, substantial corporate and personal net assets and liquidity and at least 40% of the project costs to go into the scheme in cash. Pricing from the high street banks is at the lower end of the spectrum and so for the developer who meets their underwriting criteria it can be worth pursuing but getting an application for a ‘new to bank’ customer through credit and to drawdown is like extracting teeth slowly without an anaesthetic.
The high street banks still have balance sheet issues and simply don’t want short-term property loans on their books, which carry expensive capital costs and are perceived as high risk
The challenger banks; who are they?
This is a collective name given to a few new to the market banks. They have depositors and a banking license and are structured in a way that enables them to offer both short term funding including development finance, and long term funding to property investors and trading businesses. Two of these banks will not accept business directly from the public but only via accredited brokers.
On what types of construction is residential Development Finance available?
New build: residential housing and flats
Conversions: of commercial to residential units, or from large residential units to smaller residential units
Heavy refurbishments: where work is of a structural nature and generally requires planning consent/building regulations and the construction element of the facility is sizeable and is drawn in stages.
Light refurbishments: where the work is cosmetic rather than structural and where planning consent/building regulations are not required and/or the cost of the work can be met from the clients own resources.
Is finance available to complete projects that are distressed or only partly constructed?
Yes there are lenders that will step in and finance such projects either on a 1st charge basis (by repaying the incumbent lender) or a 2nd charge basis by sitting behind the incumbent lender.
How much of the project costs can be borrowed?
This does depend on factors such as experience, location, unit type and size and profitability of the project but for schemes where total project costs are in excess of £1M, up to 90% of the costs can be borrowed from a lender(s). For smaller schemes the loan to cost ratio may be less. Lenders will often set a maximum cap on the day one land loan LTV. Debt may be in the form of senior debt (1st charge) or a mix of senior debt and mezzanine debt (2nd charge). Equity is available
to sit behind debt for sums up to 100%v LTC although most investors require a few per cent of the costs as hurt money from the developer. There is a dearth of 100% funding models; there are a few structures for experienced developers with well-located and profitable projects but lenders-investors want their pound of flesh.
How is the borrowing structured?
Funding may be structured in a number of ways:
Senior Debt and Stretched Senior Debt
This is 1st charge lending. The term Stretched Senior Debt refers to more highly leveraged senior debt funding, which is priced accordingly to reflect the higher risk. Pricing will normally be a blend of traditional 1st charge senior debt and more expensive 2nd charge mezzanine debt. Senior Debt/Stretched Senior Debt lenders will structure their loans on either a LTC or LGDV basis.
Loan to Cost Lenders or LTC
LTC lenders are those that limit funding to a percentage of the total project costs, typically to include:
• Land, SDLT, and other acquisition costs
• Construction costs
• s. 106 costs
• Professional fees
• Finance charges including interest and lending fees
LTC lenders may have a secondary cap on the maximum they will lend, measured against loan to Gross Development Value or LGDV. So for example they may lend up to 75% LTC but no more than 60% LGDV. Client cash contribution will typically be made at both the land purchase (or refinance) phase and commencement of the construction phase,
or in some cases all at the land purchase (or refinance) stage. Lenders will sometimes, but not always, set a cap on the
day one land loan as a maximum LTC or LTV.
Loan to Gross Development Value lenders or LGDV
LGDV lenders work backwards from the forecast end value, and having established their maximum loan to GDV (e.g. 55%) they set aside funds as follows:
• Accrual for estimated interest
• 100% of the construction costs and professional fees
• Any balance goes towards purchase of the land. Lenders will often set a maximum cap on the day one LTV.
LGDV lenders may also apply a secondary cap on the amount they will lend measured against Loan to Cost or LTC. So for example they may lend at 65% LGDV but no more than 80% LTC. Client cash contribution will be made at the land purchase (or refinance) stage.
This is 2nd charge or junior debt lending which ranks behind senior debt 1st charge lending in priority and as it carries higher risk it is priced accordingly. The term ‘mezzanine’ reflects the fact that it sits in between senior debt and equity (usually provided by the borrowing client). Mezzanine lenders may structure their loan based open the LTC or LGDV model. So for example they may lend up to 90% LTC or to 75% LGDV.
Equity is the ‘debt free’ element of the funding structure and normally refers to the cash contribution made by the borrower. However it can be an investment made by a third party and structured in a number of ways to include a profit share, interest, fixed fee or other arrangement. Third party equity providers may require security by way of a 2nd/subsequent charge over the project asset, and/or a share-holding in the borrowing entity, but often it is unsecured. Equity is available for well-located and profitable projects of up to c. 90% of the equity requirement (that is the balance required to fund the project after the debt provision). For example let us assume that a project is leveraged to 80% LTC from a debt provider(s); then the equity requirement is 20% LTC. If an equity provider invests 90% of this requirement, the borrowing developer has to invest 10% of 20%; that is 2% of the project costs. So for a project with a total cost of £2.5, the developer contribution would be £50k, for a project with costs of £5M, £100k and so on. Whilst it is possible to leverage debt to 90% LTC it is unusual for it to be this high in a debt-equity structure due to the debt being expensive at this leverage. It is more common for the leverage in a debt-equity structure to be 75-80% LTC; thus attracting cheaper debt funding.
This model was commonplace before the credit crunch but is very rare in the current market as lenders and investors wish to see the developer putting some ‘hurt’ money into the project. Investors may look for a return made up from a mix of interest, fixed fee or profit share arrangements.
How will the finance be structured?
The facility will be made available in two tranches. 1) Land Loan: for the purchase (or refinance) of the property/land
and 2) Building Loan: to fund the construction and professional fee costs. This part of the facility will be drawn, in arrears, in a number of tranches following a site inspection by a surveyor appointed by the lender who will check the quality
and progress of the work, ensure it meets the statutory planning consent and building regulation conditions and agree a sum for drawdown.
What is the maximum loan available in the market?
At Optima we broker property development loans from £500k (smaller loans are available generally through secondary lenders at bridging interest rates/fees). At the top end there are lenders offering funding of up to £50M per project.
What security will the lender require?
Senior Debt and Stretched Senior Debt – 1st charge on project asset
Ltd Co.’s/LLP’s – 1st Debenture & Personal Guarantees (PG’s) Inter-company guarantees where applicable
Mezzanine Debt – 2nd charge on project asset
Ltd Co.’s/LLP’s – 2nd Debenture & Personal Guarantees (PG’s) Inter-company guarantees where applicable
PG’s are required by all lenders and the amount will range from a guarantee to cover the full debt (smaller loans and secondary lenders) to limited guarantees for larger schemes from investment banks and specialist property funders; typically c. 20% of facility. Guarantors are not required to provide supporting security but lenders will wish to see that the guarantor has sufficient personal nest assets to call upon in the event of requiring recourse to the guarantee. For large loans to regional/national corporate developers PG’s may not be applicable.
Over what term are Development Finance loans offered?
The loan needs to be of a sufficient length to enable the project to be built and sold and therefore the larger and more complex the scheme, the longer the facility and the greater the potential risk to both the borrower and lender with potential uncertainty over changes to the marketplace. Typically lenders offer standard term of 12 – 24 months but with longer periods by negotiation. Generally periods that fall beyond a lenders standard policy attract a higher price.
How much will Development Funding cost?
It depends upon a number of factors including experience, risk profile, location, unit type, gearing and size of the project. What is certain though is that pricing is not, and is unlikely to be, as cheap as the pre credit crunch era. On the other hand the emergence of new entrants to the market in the last 12 months or so has brought much needed competition and the result is a reduction in pricing in areas of demand which is good news for the borrowing property developer. Lenders will earn a return on their funds by applying a variety of charging structures to include:
Interest: which may be charged on the drawn balance, calculated daily and applied monthly, or it may be charged on the offered facility rather than the drawn balance.
Non-utilisation fee: charged monthly on the undrawn element of the building loan
Lending fee in: calculated as a percentage of the offered facility or a fixed sum, either payable in whole, or part thereof, on acceptance of the offered facility or drawdown of the first tranche of funds.
Lending fee out: charged on the repayment of the facility calculated as either a percentage of the facility, a percentage of the GDV of the project, a fixed fee or a fee based upon the profits generated from the project. Typically a fee is taken from each unit sale.
There is a wide range of pricing in the market (even for similarly leveraged funding structures) and it would be misleading to attempt to cover these in this text. Comparing interest rates alone is misleading and all charges whether they be interest or fees must be taken into account when assessing the competitiveness, or otherwise, of a development finance product and the only way to get an accurate comparison is to run the project numbers through a development finance calculator or appraisal. We have prepared a comprehensive range of products which can be viewed at the web site under Development Finance Products , and there are examples of development finance calculators and appraisals in the Resources section of the website.
What experience will applicants need to have?
Most lenders, and certainly for larger schemes, will only lend to experienced developers who can demonstrate they have profitably built and sold a similar project to the one that they are seeking finance on. However some lenders will consider applications from industry professionals without experience, or inexperienced developers on smaller schemes subject to the deployment of an experienced team to include a contractor and project manager. Inexperienced applicants should have a significant cash contribution and should not expect to be offered stretched senior debt to 90% LTC on a 50 unit scheme!
Will the developer have to deploy a building contractor on a fixed price JCT?
No not necessarily. Large and complex schemes will generally have a JCT structure but many small to medium sized developers operate by deploying sub-contractors and direct labour and managing the project themselves. This is usually acceptable to most lenders providing the developer can demonstrate experience and success using this structure.
What legal entities will lenders fund?
Sole traders, partnerships, LLP’s, Ltd Co.’s and offshore vehicles. When the vehicle is to be a Ltd Co, lenders will often prefer it to be a Special Purpose Vehicle, or SPV, set up for the specific project and owning only the project asset/liability. Where the borrower is to be an offshore vehicle full disclosure and audit of the directors and beneficial owners is required.
How will the lender put a value on the project?
A development finance lender will appoint a professional firm to carry out the following:
GDV: A valuation of the Gross Development Value, or GDV (end value) of the completed project. Although the project may not be built for a further 18 months or so the GDV is based upon what the value of the scheme would be if it were on the market for sale on the date of the valuation. Therefore no account is taken for any forecast changes, positive or negative, in the market.
RLV: A valuation of the Residual Land Value, or RLV, which is the value of the land/property, in its current state
(i.e. not constructed) but with the benefit of the current and relevant planning consent.
The RLV is calculated backwards from the GDV and a brief summary follows:
Developer’s profit (varies but typically 20% ROC/17% ROS)
Professional fees Marketing costs
S. 106 costs (if applicable) Finance costs (at market rates) Disposal costs
SDLT & costs of acquisition
The appointed valuer, or often an independent Quantity Surveyor, is asked to assess whether the clients estimated
construction costs and professional fees are sufficient to construct the project.
What due diligence will the lender undertake on the project?
The lender, and/or, the appointed professional team (valuer/QS/lawyers) will review some or all of the following (although not necessarily all at the beginning of the process). The level of due diligence will vary from lender to lender.
A brief overview (one page maximum) of the project and the financial requirements.
About the Developer and the Team
• CV/Portfolio of projects
• Accounts/financial statement of affairs including details of other current schemes, if applicable
• A&L statements of directors/major shareholders
• Details of the intended borrowing vehicle including directors/shareholders
• A credit reference agency report on directors/major shareholders and a search on any company borrower
• Evidence and source of clients intended cash injection into the project
• Statutory money laundering requirements (ID/Residency etc.)
• Developers professional team including Architect, QS, Structural Engineers, Contractors, M&E, Selling Agents, Lawyer
for professional competence, PI cover and financial creditworthiness (where applicable)
• Collateral Warranties may not be required from the professional team (Architect, Structural Engineer etc.)
About the Project
• A robust development appraisal where estimated GDV and construction costs/professional fees are realistic to conservative.
• Evidence of comparable GDV figures from both local selling agents and on-line data sources
• Detailed breakdown of construction costs and professional fees
• The scheme should be showing a minimum return on costs (ROC) of 25% before application of finance
charges (20% return on sale or ROS)
• Build and sales programme and cash flow detailing periods for pre-construction, construction and sales
• Marketing and sales plan with schedule of accommodation
• Valuation or desk top if one is to hand
• Title Documents; to ensure good and absolute legal title and appropriate legal searches
• Site plan and scheme drawings; for design, access, construction matters
• Planning consent to ensure that the consent is valid, workable and not onerous. All pre development conditions must be satisfied before a lender will advance any money on the construction element of the loan (and some lenders will not advance the land loan element if the conditions are onerous). Note; some lenders are now accepting
applications under the General Permitted Development Order, where inner city commercial units can be converted to residential units without the need for a planning consent
• s. 106 agreement if applicable
• Construction Warranty. Most lenders, but not all, will require the scheme to be covered by a warranty such as NHBC, Premier, BLP etc. Warranties are available for conversions and heavy refurbishments as well as new build property but shop around!
• Most lenders will accept a warranty that is acceptable to the CML (Council of Mortgage Lenders) for residential mortgage purposes. It is worth noting that term lenders offering residential investment finance are increasingly requiring completed units to be covered by a warranty and are either declining applications where there is not one, or offering a reduced LTV
• Building regulations; prior to commencement of construction
• Party wall agreements; if applicable
• Appropriate insurance policies (fire/contractors all risks/public liability etc.)
• Desk top (phase 1) and intrusive ground reports (phase 2) for contamination, soil composition/footings design etc.
• Structural engineers report, if applicable
• A valuation of GDV and RLV from a RICS Valuer
• An assessment of build costs/professional fees from a Surveyor
How would you describe the commercial property Development Finance market?
Finance for the development of commercial property is generally only available if the to be completed unit(s) are either pre-sold or pre let or if there is long term commercial mortgage finance in place to repay the development finance lender.
However one seasoned residential development lender has just announced (December 2015) they will consider funding speculative commercial developments of office and industrial units (retail and leisure by exception) in and around the M25. Maximum loan to GDV 60%, loans up to £10M. Please refer to the Development Finance Products suite on the web site for details
How would you describe the student accommodation Development Finance market?
There is shortage of bespoke student accommodation in certain geographical locations and therefore demand from operators for finance to construct new student blocks. We are currently researching the market for this product and
will update this section as soon as we have something of value to add. We will also update the Development Finance Products suite on the website.
Can you provide examples of currently available Development Finance products?
For examples of currently available products visit Development Finance Products on the website.As the number of lenders and products are numerous it would be cumbersome to provide details of all so we have included those that are market leading or have a USP. Please contact us to discuss your project and we will always aim to match a lender and product to your requirements.
What resources are available to property developers to assist them in raising finance?
We have provided a number of tools which you may find of us (aide memoirs/appraisals/cash flows/ A&L Templates/ Calculators etc.); to view and download please visit the Resources section of the web site. We have provided a list of industry links that you may find of use (Planning Portal/RICS/RIBA/Law Society/ Warranty Providers/Sales Data etc.); to view visit the Industry Links section of the website.
How can Optima help property developers with their finance application?
The search for suitable finance may be complex and time consuming, and the developer may not have the time or market knowledge to ensure that the most appropriate offer is secured. We regularly see offers of finance that could be significantly bettered. At Optima we have the experience and the contacts to broker market leading development finance products and would be pleased to discuss either a specific project or the market in general with you; and of course in confidence.
To get an understanding of how we offer a professional and transparent brokerage service please view the About Us and Successes pages of the web site where we have posted both testimonials from satisfied clients and examples of project case studies.
If you have a specific enquiry about Development Finance, or wish to discuss the market in general, or indeed require clarification on anything you have read in this article please do get in touch.