Diagram showing the step-by-step stages of property development finance, from planning and funding to construction and completion
Property development is a form of finance that is generally used to fund the acquisition of land/property and the subsequent development of it. There are a number of important factors to consider when seeking property development finance; some of these will be discussed in this article.
This guide explains how property development funding works in practice, helping developers understand the process before applying for property development finance.
Who offers property development finance?
Property development finance is offered by a number of different lenders, from high street banks to specialist development finance lenders. While high street banks are generally able to offer the most competitive rates, they are faced with stricter lending criteria, meaning they are only able to lend on certain schemes. While lending criteria will differ from lender to lender, most lenders will prefer a profitable project in a well-located area, carried out by a highly experienced and skilled developer. On the other hand, certain specialist lenders or private investors are more likely to lend to first-time developers on more risky projects. With the above in mind, developers with a well-established relationship with a high street bank will likely be offered the best development finance facility from their existing lender.
On the other hand, developers who do not have an established relationship with a bank or have difficulty sourcing finance through traditional routes should approach a development finance broker for help in sourcing a suitable development finance facility. One of the reasons for this is that there are hundreds of development finance lenders across the UK, from specialist lenders to private individuals, and navigating this network of lenders can be a time-consuming task.
For developers looking for tailored funding solutions, working with a specialist broker can simplify access to the right development finance lenders in the UK.
How is development finance structured?
Development finance can be structured in a number of different ways and can be altered to suit the funding needs of the developer and the project.
The structure of funding varies depending on the type of property development project and finance strategy, which is why understanding lender requirements is essential.
One of the most common ways in which development finance is structured is a series of tranches. Generally, property developments are structured in the same way. Firstly, the developer will purchase a parcel of land or an existing property; the property will either already have planning approval, or the developer will obtain planning approval.
Once planning has been approved, the developer will begin the construction of the property. Upon completion of the property, the developer will either rent out the property or sell it on the open market. Property development finance is tailored to this process in a way that enables the developer to complete the project whilst minimising the funder’s exposure to risk. Development finance will generally be split into two (or more) tranches.
The first tranche is a land loan and will be released in order to assist the developer with the purchase of the land. Once the land has been purchased, the lender will release a construction loan, which will enable the developer to construct the development. The construction loan will likely be structured in several tranches, released in accordance with the construction schedule. These tranches will be released in advance or arrears.
If they are released in advance, it means they are released before the work has been done, to fund the work. If they are released in arrears, it means they are released after the work has been done to reimburse the developer for the cost of the works.
Developers often combine different funding layers depending on project size, including senior debt, mezzanine finance, and equity.
Important Factors to Consider:
Valuation: As part of the application process, the lender will conduct a valuation of the property to confirm its value as security. This is one of the most important steps in the application process, as an insufficient valuation can result in a failed application. With this in mind, it is important to ensure that you have an accurate estimation of the property’s value before applying. A strong valuation supports better loan terms and improves approval chances when applying for development funding.
Timeline: Property developments rely heavily on the timing of the project, as delays can prove costly, digging into the profitability of the development. With this in mind, it is crucial to ensure that the timeline of the funding is well aligned with that of the project. Delays can increase finance costs, especially when interest is rolled up over the term of the loan.
Monitoring Surveyor: Another important aspect of development finance to consider is the monitoring surveyor. Monitoring surveyors are dispatched by the lenders (and paid for by the borrowers) in order to track the project’s progress and ensure that the funds are released in accordance with the project’s timeline. This process ensures lenders minimise risk while maintaining structured fund releases throughout the project lifecycle.
Exit: When analysing the strength of a development, lenders will scrutinise the developer’s planned exit. This will likely be one of two options. Firstly, developers may plan to sell the property upon exit, using the proceeds of sale to repay the lender. Secondly, the developer may look to hold onto the development, let it out, and refinance into a longer-term mortgage. While both of these are considered viable exits for lenders, it is important to discuss your planned exit strategy with the lender before putting in an application. Many developers refinance completed projects into long-term facilities after exit, depending on their investment strategy.
When Should You Use Property Development Finance?
Property development finance is typically used when:
- Purchasing land for development
- Funding ground-up construction projects
- Converting existing buildings into new use
- Scaling property investment portfolios
Understanding when to use this type of funding helps developers choose the right financial structure for their project.
Conclusion
In conclusion, there are a number of important factors to understand when it comes to development finance, each with varying degrees of importance. While all these factors can influence the success of an application, working with an experienced broker can significantly improve outcomes.
If you are planning a project, explore your options for property development finance in the UK to secure the right funding structure.
