The development finance market can be complex and difficult to navigate, especially for first time borrowers. The sheer number of lenders, each offering their own products, can be overwhelming to developers seeking the best facility for their project. This article will provide a full guide to development loans for property projects UK developers and investors commonly use.
What are development loans for property projects?
Development loans are a specialist form of property development finance used in the UK to fund the purchase and construction of new builds, refurbishments and renovations. Where traditional mortgage finance does not allow for heavy structural work or ground up development, property development loans UK lenders offer are specifically tailored for these types of projects. It is important to understand how development loans work UK developers and investors use before engaging with a lender or broker. Here are the most important point to understand:
Drawdown Structure:
Development finance loans UK lenders provide are not structured the same way as a traditional mortgage, where the full loan amount is released on day one. Development finance facilities have multiple tranches that are released in alignment with the stages of the project. The first tranche is the land loan and is released by the lender to assist the borrower in purchasing the property. The land loan can also be used to refinance any existing debt on the property (if it is already owned by the borrower). Generally, the land loan will not exceed 75% of the purchase price of the property, but this will depend on the overall loan to cost and loan to gross development value of the project. Once the property has been purchased and the works have begun, the lender will provide the borrower with a construction loan. The construction loan can be structured in a number of ways, but it is usually drawdown in tranches. These tranches can be structured in a number of ways. Firstly, the tranches can be funded in arrears, meaning that the developer will self-fund the first stage of construction. Once the first stage has been completed, the lender will verify that the work has been completed (using an independent MS), before reimbursing the developer for the cost of the works. This is a common form of development finance and is commonly used for ground-up construction projects. Another form of construction finance is a peak-debt facility. Peak-debt facilities are used for larger, staged developments where some units are completed and sold before the construction works have finished completely. Peak debt facilities are structured similarly to a revolving credit facility. The lender will make a facility available to the borrower that they will drawdown on to fund the works in stages. As certain units are completed and sold, the proceeds will be used to repay the lender, before the developer draws the next tranche from the facility. The end result of a peak-debt facility is that the total outstanding debt at any given point does not exceed a certain amount (the peak debt amount), meaning that the borrower does not pay interest on unused funds.
This type of structure is commonly used within real estate development funding UK lenders offer for larger staged developments.
Interest Rates:
Interest rates are another important factor to consider when exploring development loans for property projects in the UK as a funding option. Where interest rates on mortgages can be as low as a few points over base, development finance often coms at a hefty premium. The reason for this is that development finance is considered significantly riskier for the lender. Where traditional mortgages are secured against a property with a stable and verifiable value, development finance facilities are often secured against part-built construction sites, making it difficult to verify their value and potentially impossible to sell. While the interest rate is likely to differ depending on the project, it is important to understand that lenders will prefer to fund straightforward projects with experienced lenders and their interest rates will reflect this.
Loan Repayment:
An important factor to understand and communicate to the lender will be how the loan will be repaid upon completion of the project. There are a number of common repayment strategies with the most common being through the proceeds of sale of the completed development and through refinancing the debt onto a longer term, traditional mortgage. Both of these options are suitable exit strategies for lenders, although developers will have to demonstrate that there is sufficient demand for their development or that the income from the development can support a long term mortgage, either way it is important to clarify how the loan will be repaid from the start.
Borrower Criteria:
Perhaps one of the most important factors considered by lenders is the borrower’s profile. Borrowers with limited experience or failed past projects are less likely to secure financing than experienced borrowers with a strong track record of successful developments. For new or inexperienced borrowers applying for property development loans UK lenders offer, it is crucial to have an experienced professional team, including contractors, architects and project managers in order to mitigate the risk of being a first time developer.
In conclusion, there are a number of important factors to consider when applying for development loans for property projects UK lenders provide. It is vital to ensure that you fully understand how development loans work UK borrowers use prior to engaging with any lenders. In this way, having a skilled mortgage advisor by your side can prove invaluable.
