Development Finance Guide

If you are considering taking on a development project and need to understand the basics, our development finance guide will help.

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Development Finance Guide

Author: Darren Ferguson – Development Specialist & Owner

Published: 4th May 2023

Updated: 29th August 2023

Read Time

Read Time – Approximately 8 Minutes

Our development finance guide should be helpful, but it’s always best to speak with an adviser to discuss your own personal circumstances and to get the best advice. Call us on 01604 212879 should you have any questions.

What is development finance?

Development finance is a form of short-term finance used to fund a property redevelopment, conversion or ground-up construction.

It can be used to cover the costs of property development, including but not limited to the following:

  • Land acquisition
  • Construction costs
  • Legal fees

The finance can be secured against land, residential and commercial property. It is available from mainstream banks, building societies, specialist lenders, and other financing facilities such as crowdfunding.

Financing is typically borrowed for terms up to 36 months, dependent upon the nature and size of the project, and is repaid from the sale or refinancing of the completed project.

What is the difference between bridging finance and development finance?

They are both essentially forms of short-term borrowing, so what is the difference?

Bridging finance is typically:

  • Used for short-term funding to bridge a gap, such as purchasing a property until another has sold.
  • Over a shorter period, on average, 6 to 7 months
  • Used for acquisition and refurbishment as opposed to development

Development Finance is a specific form of finance used where significant work is undertaken on a project, whether a complete property conversion or a ground-up development, such as a multi-unit block of flats or houses. Funds will generally be borrowed to cover both the cost of the site acquisition and any work that needs to be completed. It can be multi-layered in terms of senior debt or stretched senior debt and mezzanine funding (2nd charge).

How does development finance work?

It works by providing funding towards the acquisition of a site (that will typically have planning approval) and the construction costs of the development. Development lenders will typically look to lend an amount up to a certain percentage of the end value of the completed project, referred to as the gross development value or GDV for short.

The funds lent will typically cover 100% of the expected construction costs and an amount toward the initial site purchase, usually 60 to 65%, with the remaining shortfall to be covered by the developer (or in some instances, other equity investors)

Typical development projects could include:

  • Single or multiple new build properties (residential & commercial)
  • Conversions (for example, offices to residential units)
  • Large-scale refurbishment projects
Construction crane on development site

How much can I borrow?

The amount you can borrow will depend on several factors, such as the nature and size of the development project and your experience. Many lenders have a minimum loan size of £500,000 and can lend up to £25m or more for the right project and developer.

For smaller projects, there are a select few lenders who can provide funding for loans below £500,000, call us to find out more.

When calculating potential loan amounts, development lenders will typically use one of the following two metrics to calculate the maximum loan:

  • Gross Development Value (GDV) – This is the end value of the development project once its complete, and lenders will typically lend no more than 65% to 70% of this value. Its important to note that this figure is the gross loan amount, meaning it will be inclusive of fees and interest, therefore the net amount received will be less. The longer you have the loan for, the more interest to pay, which in turn reduces the net loan amount.
  • Loan to cost (LTC) – This is the amount of the loan divided by the project’s total cost, which will typically be a maximum of 85% to 90%, but again could be lower. For example, should a borrower be looking to borrow £1.5m against a project costing £2.5m, the loan to cost (LTC) would be 60%.

The lender will then break the loan down into two parts:

  • The Build Loan – funds used to complete the build
  • The Land Loan – funds used to acquire the site or land.
Rolled Up Interest

The Build Loan

From the lender’s perspective, the build loan is the most critical aspect of the two loan components, so the lender will always look to fund 100% of this to ensure sufficient funds are available to complete the development.

The build loan typically covers the following:

 

  • Finance costs (interest and fees)
  • Any professional fees
  • The build and contingency costs
Rolled Up Interest

The Land Loan

Once the required funds for the build loan have been calculated and allocated, the amount left over is essentially what’s available for the land loan, with the developer required to make up the shortfall and fund the deposit to acquire the land.

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Why do business with us?

Development Finance is a complicated type of funding, and advice should be sought from a qualified broker to source the right finance.

How is development finance structured?

Development finance can be structured as a series of layers.

Senior Debt

This is effectively the 1st and primary charge over the development, much like a mortgage would be on your home. It has the overriding charge and would be the first to be repaid once the project is complete. Senior debt will typically max at 60% to 65% of the GDV.

Stretched Senior Debt

As the term suggests, this is effectively a ‘stretch’ on the senior debt, meaning the lender can offer a higher LTV against the GDV or Loan to Cost (LTC) than they ordinarily would, perhaps up to 75% of the GDV.

Given the enhanced LTV, it is generally only available to experienced developers.

Mezzanine Finance

Mezzanine finance is effectively a form of 2nd charge borrowing, meaning it will sit behind the senior debt in terms of priority and will be funded by a different lender to the senior debt. It can be used to increase the available funds and reduce the equity a developer might need to inject.

As it’s a 2nd charge, it’s higher risk and will therefore attract higher rates, but it can be helpful where a developer has limited funds, perhaps because they are working on multiple projects.

Equity from investors

Sometimes, a developer may not have the total funds to fund the deposit, so they may look to bring an investor on board who can inject equity (cash) into the project. Typically, this arrangement might work on a profit-share basis with the investor and may seem more appealing, due to the rates, than pursuing mezzanine finance.

It would be prudent to explore both structures depending on the profit share. Mezzanine finance may be more profitable even at higher rates and will allow you to retain full control over the project. In contrast, an investor might want a certain level of control over the development.

If equity partners are an option you would like to explore, please get in touch, and we have contacts who can assist.

What are development finance interest rates?

Unfortunately, there is no easy answer to this, as several factors are involved, such as the size of the project, the leverage, the risk, experience and borrower profile. You could go to 20 different lenders and get 20 different terms.

Typically the central high st banks can offer more favourable rates but will be stricter in their requirements and cost calculations. In contrast, other specialist development lenders will be slightly higher but more flexible in their lending appetite.

As a general guide, the differences between mainstream banks and specialist development finance lenders are as follows:

From Main Stream Banks

  • Typical Max Loan To GDV (LTGDV) 60% 60%
  • Typical Max Loan To Cost (LTC) 75% 75%

Typical Rates (£1m+) – 4% to 7%

Typical Rates < £1m – 5% to 8%

Mainstream banks will look to offer more favourable terms but will be much more cautious in their appetite, with more restrictive loan-to-values on both the GDV and loan-to-cost.

From Specialist Lenders

  • Typical Max Loan To GDV (LTGDV) 70% 70%
  • Typical Max Loan To Cost (LTC) 90% 90%

Typical Rates (£1m+) – 6% to 10%

Typical Rates <£1m – 8% to 12%

Specialist lenders will generally be a higher cost in terms of rates but will be far more flexible in terms of appetite and approach, with higher Loan to value and Loan to costs ratios

How do I work out which deal is best?

Ultimately, what is best for one developer may not be best for the next, as they may require different funding requirements.

However, the following formula can help to offer a simplistic comparison of terms from  different lenders:

  • Divide the annual interest charged by 12
  • Then add the percentage of the arrangement fee and the exit fee
  • Divide by the number of months of the loan

For example:

(interest rate charged / 12) + ( Arrangement Fee % + Exit Fee %) / number of months of loan

For example, if the rate was 8%, Arrangement fee was 2%, the Exit fee was 1%, and the loan term was 18 months.

(8% / 12) + (3% / 18) = 0.83% per month

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What are the fees for development finance?

Fees will vary from lender to lender and the below is a summary of the typical fees lenders might charge.

Arrangement Fee

A fee that the lender charges that will typically be added to or deducted from the loan advance. The fee is usually a percentage of the loan amount, ranging from 1% to 2%.

Valuation Fee

Lenders will typically require a valuation of the initial site or land, and this fee will depend upon the development’s size.

It should be noted that this initial valuation fee is separate from any ongoing monitoring or reinspection visit as the development progresses.

Legal Fees

You’ll be required to cover the legal fees for yourself and the lender involved. Again, the amount of these fees will depend upon the nature and scale of the project.

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Development Monitoring Fees

As the development progresses throughout the various stages, lenders will want to monitor and re-inspect the site to ensure it is progressing as agreed and to the standard of work required. Fees are likely to be charged for each visit and inspection.

Development Exit Fee

This is a fee charged by the lender when the loan is repaid. It is usually a percentage of the loan amount but can be a flat fee.

Some lenders may calculate the exit fee based on the loan amount borrowed, whilst others might base it on the GDV, which could make a substantial difference to the fee paid.

Interest Fees

Likely to be the highest cost in terms of development funding.

Interest is typically rolled up during construction and repayable when the development is completed.

Interest is usually only payable on the drawdown of each agreed tranche of funding.

What is the typical process for a development loan?

The process for a typical development loan will be as follows:

Initial Application

The borrower makes an initial application to a development lender, providing details about the proposed project, funding requirements and details of experience.

Lender Assessment

The lender will undertake a full assessment of the development proposal, taking into account the following:

 

  • Location of the proposed development
  • Experience of the borrowers and the supporting team
  • Nature and size of the proposed development
  • The potential end value of the project referred to as the gross development value or GDV.

Development Loan Offer

Should the lender be happy with the nature of the proposed development, they will issue a formal offer outlining the terms of the development loan, including the following:

 

  • Total development loan facility. This will usually be broken down into two parts, the build loan and the land loan.
  • Interest rate and Fees payable
  • Term of the loan
  • Any other terms and conditions

Valuation and Legals

The lender will evaluate the proposed development site and instruct solicitors to undertake the required legal work.

Funds Released

Typically funds will be released in pre-agreed tranches or stages of the development project. Borrowers may usually have to fund the first stage of the development, which will then be assessed once complete, and the initial phase of funding released, and so on until the development is completed.

Repayment of the development loan

Typically the interest on the loan will be rolled up and deferred until the development is completed. The borrower may also choose to service the loan throughout the project.

Completion of the development

Once complete, the loan will need to be repaid in full, which could either be from the sale of the development or refinance onto a longer-term loan, such as a buy-to-let mortgage, or a development exit bridge to provide a longer term to allow for the sale of the site.

What documentation will be required?

Development lenders will require a lot of information to assess the viability of any potential development appraisal fully. The more information you can supply and the better prepared you appear, the more likely the lender will offer a favourable decision.

Lenders will require the following documentation to assess an application:

Development CV

A summary of completed past projects to include the nature and size of the project, dates, locations and outcome.

Full Development Appriasal

A complete appraisal of the costs involved and profits to be made. It should essentially be a full financial feasibility test of the project.

Build Schedule

A full schedule of the properties to be built, including type, number of units, expected sales prices and square footage

Planning Documents

Details of any planning consent and restrictions

Borrower Funds

Breakdown and evidence of the amount and source of any borrower funds to be injected into the project, including details of any other investors and involvement.

Assets & Liabilities Breakdown

A breakdown of all assets and liabilities for all borrowers. Even if the proposed development is in a company name, lenders will still require a complete A&L statement of your personal situation.

Proof of Address

Valid Passport and proof of address, typically a recent utility bill dated within the last 3 months.

Details of Exit Strategy

Full details of how the finance will be repaid, whether from the sale of the units or for the loan to be refinanced onto a longer-term mortgage or development exit bridge.

How To Apply

Its simple to apply, just call us on:

01604 212879 and we’ll handle everything for you.

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Let’s talk you

It’s not just about the property. You’ll need to meet specific criteria, so it’s important we understand a little about your background to make sure we find the best option for you. Time spent at the front end is time saved at the back end!
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Let’s talk property

We’ll need to know all about the property, such as value, type, location, income and ultimately, your plans. The more we know, the better, and we’ll guide you through what we need to know.
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Let’s talk options

Time to piece it all together and talk about your options. We’re firmLets get movin believers in straight talking, so we’ll tell you what can and can’t be done and present you with options best suited to your requirements.

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Let’s get moving

If you’re happy with the options discussed, it’s time to get things moving and get an agreement in principle. We’ll handle everything and support you along the way to help ensure your application is as smooth as possible.

Find out more about regulated bridging loans

Read more about bridge to let mortgages

Learn more about limited company buy-to-let mortgages

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Development Finance FAQ’s

Can you get development finance if you have bad credit?

Yes, development lenders are generally more flexible than residential mortgage lenders. So long as a reasonable explanation is provided and the lender can get comfortable with its background, it can be acceptable in most instances. It’s always important to disclose this information upfront, as it will likely come to light during the application process.

What is a suitable exit strategy for a development loan?

Before agreeing to any development loan, the lender will want to have a clear understanding of what the intended exit strategy is. 

The exit will generally be one of 3:

  • Sale of the project once complete. 
  • Refinance the project once complete. This could be either onto a long-term mortgage if the intention is to retain the units and let them for investment purposes or perhaps onto a development exit bridging loan. 
  • Combination of the 2, sell some of the first completed units to clear the development lending and retain others for investment purposes.

Do I need experience to get development finance?

Experience is a critical requirement for a lot of development finance lenders. Typically they’ll want to see at least 2 to 3 completed projects before considering a new proposal.

Getting experience is challenging if you can’t get funding and haven’t got the funds yourself, but there are options.

Whilst some lenders can lend to first-time developers, it’s unlikely they will lend on ground-up new developments of multiple units unless supported by a strong team around them.

They may be more receptive to a conversion or something under permitted development. Start small with a couple of projects and gradually build up; this will have been the typical starting point for most experienced developers.

Thanks for reading our development finance guide!