Finance for Property Developers

Finance for Property Developers

FAQs

 Here are some frequently asked questions we are often asked. If you have any other questions about our products, that you can't find here, please get in touch with us and we will be happy to answer any queries you have.

Q. How would you describe the Residential Property Development Finance market at the moment in terms of both demand for and supply of finance?
Demand for quality family, first time buyer and investment housing is strong and aided by low interest rates (although dampened a tad by Government policies such as the Mortgage Credit Directive which has made it more difficult to get mortgage and various pieces of legislation making it less attractive to BTL investors), but there is insufficient supply thus fuelling price increases. Not surprisingly therefore there is an increased demand for finance from property developers.
 
On the supply side availability of finance has improved significantly over the last few years with 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 remains a dearth of 100% funding models; there are a few structures for experienced developers with well-located and profitable products but the lenders-investors want their pound of flesh. There is a wider pool of available equity, to sit behind debt and take leverage up to near 100% LTC, if the developer is able to contribute a few per cent of costs as hurt money.
 
Increasing and diverse sources of supply is driving the cost of borrowing down; albeit slowly. As a rule of thumb, and certainly for prime borrowers, the lower the leverage the lower the pricing.
 
There is also a much improved supply of long term investment finance for residential property portfolios (not withstanding tightening of underwriting by the Prudential Regulation Authority in 2017) 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.
Q. What types of institutions are lending?

Investment banks, challenger banks, specialist property funds, peer to peer platforms, family offices, private and institutional investors, bridging lenders; all of whom have expanded their markets and moved into traditional high street banking space.

Q. 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.
Q. On what types of construction is residential Development Finance available?
New build: residential housing and flats
 
Conversions: of commercial to residential units (under planning consent or Permitted Development Rights), 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.
Q. 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 / 75% GDV can be borrowed from a lender (s). 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% LTC although most investors require a few per cent of the costs as hurt money from the developer. There is a dearth of 100% LTC funding; a few structures exist for experienced developers with well-located and profitable projects but the lenders-investors want their pound of flesh.

Q. 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 80% LTC but no more than 65% LGDV. Client cash contribution will typically be made at the land purchase (or refinance) phase. 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. 65%) 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.
 
  • Mezzanine Debt

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

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 (strictly speaking it is then debt not equity but this is splitting hairs), and/or a shareholding in the borrowing entity, but often it is unsecured. Equity is available for well-located and profitable projects, typically 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 at 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 the 20%; that is 2% of the project costs. So for a project with a total cost of £5M, the developer contribution would be £100k, for a project with costs of £10M, £200k 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 high leverage. It is more common for the leverage in a debt-equity structure to be c. 75- 80% LTC, thus attracting cheaper debt funding.

 

  • 100% Funding

There are a few 100% structures for experienced developers with well-located and profitable projects. Investors may look for a return made up of a mix of interest, fixed fee or profit share arrangements.

The facility will be made available in two tranches:

Land Loan: for the purchase (or refinance) of the property/land and

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.
Q. 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
 
Personal Guarantees
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 or for full costs and interest over runs.  Guarantors are not required to provide supporting security but lenders will wish to see that the guarantor has sufficient personal net 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.
Q. 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 few years has brought much needed competition and the result is a reduction in pricing 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 compounded monthly, or it may be charged on the offered facility rather than the drawn balance. Some lenders, notably mezzanine lenders, charge interest on a flat rather than compounded structure.
  • Non-utilisation fee: charged monthly on the undrawn element of the building loan. This is not particularly common.
  • 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 appraisal and cash flow.
 
Examples of products and pricing may be viewed in the Free Guide to the Top 20 Finance Products for Property Developers which can be downloaded on the home page of this web site.
Q. 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 construction industry professionals, construction contractors 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!

Q. 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.

Q. 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.
Q. 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:
 
GDV
Minus
Developer’s profit (varies but typically 20% ROC/17% ROS)
Construction costs
Professional fees
Marketing costs
S. 106 costs (if applicable)
Finance costs (at market rates)
Disposal costs
SDLT & costs of acquisition
RLV
 
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.
Q. What 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.

Executive Summary
A brief overview (one page maximum) of the project and the financial requirements.
 
About the Developer and the Team
  1. CV/Portfolio of projects
  2. Accounts/financial statement of affairs including details of other current schemes, if applicable
  3. A&L statements of directors/major shareholders
  4. Details of the intended borrowing vehicle including directors/shareholders
  5. A credit reference agency report on directors/major shareholders and a search on any company borrower
  6. Evidence and source of clients intended cash injection into the project
  7. Statutory money laundering requirements (ID/Residency etc.)
  8. Developers professional team including Architect, QS, Structural Engineers, Contractors, M&E, Selling Agents, Lawyer for professional competence, PI Cover and financial creditworthiness (where applicable)
  9. Collateral Warranties may be required from the professional team (Architect, Structural Engineer etc.)

About the Project

  1. A robust development appraisal where estimated GDV and construction costs/professional fees are realistic to conservative.
  2. Evidence of comparable GDV figures from both local selling agents and on-line data sources
  3. Detailed breakdown of construction costs and professional fees
  4. The scheme should be showing a minimum return on costs (ROC) or return on sale (ROS) of before application of finance charges. The amount required will depend upon specific lender policy but typically will be a minimum of 20% ROC (17% ROS) for standard senior debt, 25% ROC (20% ROS) for stretched senior debt / mezzanine and potentially higher returns for equity investment. The project length will have an impact on post finance profitability and thus pre finance target returns.
  5. Build and sales programme and cash flow detailing periods for pre-construction, construction and sales
  6. Marketing and sales plan with schedule of accommodation
  7. Valuation or desk top if one is to hand
  8. Title Documents; to ensure good and absolute legal title and appropriate legal searches
  9. Site plan and scheme drawings; for design, access, construction matters
  10. Planning consent (or Permitted Development Rights) 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).
  11. s. 106 agreement if applicable
  12. 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!
  13. 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
  14. Building regulations; prior to commencement of construction
  15. Party wall agreements; if applicable
  16. Appropriate insurance policies (fire/contractors all risks/public liability etc.)
  17. Desk top (phase 1) and intrusive ground reports (phase 2) for contamination, soil composition/footings design etc.
  18. Structural engineers report, if applicable
  19. A valuation of GDV and RLV from a RICS Valuer
  20. An assessment of build costs/professional fees from a Surveyor
Q. Is it possible to take equity from a completed built project which has not yet sold?
In the last year or so we have seen the emergence of Developer Exit Finance (or Sales Period Finance) from a handful of lenders who will repay the incumbent development finance lender, add a slice of equity release on top and offer the facility over an extended period which will potentially enable the units to be sold without having to give away large discounts. Some of these lenders will agree to a repayment programme where they take less than 100% of the sale proceeds of each unit, thus creating further positive cash flow for the borrower.
Pricing for this product is generally competitive and often lower than the incumbent development finance product (the lender is carrying only the sales risk as the units have been constructed).
 
An alternative may be to source a slice of mezzanine to sit behind the incumbent development lender; thus providing equity release.
 
Securing equity release can assist property developers to move onto the next project.
Q. What funding is available to acquire an asset which requires a change of planning use before it can be constructed?

The asset will need to be secured by way of Bridging Finance which is available on residential and commercial property and land with either Outline or Ful planning consent. Wherever possible we suggest that the bridging finance lender be also able to offer appropriate development finance, so as to avoid the need, with the associated costs and hassle, of having to re finance to a different lender once the appropriate planning consent has been granted.

Q. Is development finance available on a site with Outline Planning Consent?

Not as a general rule although it is possible (though challenging) to get a development finance lender to offer funding if the reserved matters are inconsequential. It is very rare though. Therefore Bridging Finance will be required.

Wherever possible we suggest that the bridging finance lender be also able to offer appropriate development finance, so as to avoid the need, with the associated costs and hassle, of having to re finance to a different lender once the reserved matters have been satisfied.

Q. 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 Purpose Built Student Accommodation (PBSA).

There are several lenders (senior debt, mezzanine) offering development finance to experienced student operators for speculative projects (i.e. not being pre let to an operator such as a university – clearly with this in place funding becomes more readily available).  

Location is key; some lenders restrict lending to Russell Group towns only, others are advised on suitable locations by professional services firms such as Savills and Knight Frank.

Q. 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 a few lenders will consider funding speculative commercial developments in locations of demand at medium leverage.

Q. 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 page and take a look at Testimonials from satisfied clients.

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