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.
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.
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.
Funding may be structured in a number of ways:
- Senior Debt and Stretched Senior Debt
- Land, SDLT, and other acquisition costs
- Construction costs
- s. 106 costs
- Accrual for estimated interest
- 100% of the construction costs and professional fees
- 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 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
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.
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!
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.
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.
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.
- 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 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) 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.
- 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 (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).
- 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
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.
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.
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.
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.
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.