Development finance refers to borrowing money short-term for the purpose of developing a property, specifically for renovations and refurbishments. It is a popular source of finance for property developers and investors who are looking to renovate a property and sell it at a higher price or rent it out to the public.
Loans typically last for 3 to 24 months, range from £50,000 to £250 million and are secured on the property in question so the borrower risks losing the estate if they cannot keep up with repayments.
Why use development finance instead of a mortgage?
Development finance is commonly seen as a way of breaking the property chain and the lengthy process involved with mortgage applications. If the investor has a deadline for a property, they may be able to get the finance they need from a specialist lender like Aldermore or UTB, rather than having to wait several weeks for a mortgage to go through.
Similar to a mortgage, development loans can be used for residential, commercial and new build properties. So for those looking to build an estate and rent it out to tenants, either individuals or shop owners, this is a popular way of getting in the investment you need.
How much can you borrow?
The amount you can borrow for property development loans is based on the gross development value (GDV), which is what the property will be worth when all the planned renovations have been completed. The costs are broken down into two parts, construction and land costs.
The construction costs refer to all the physical building work required such as materials, architects and contractors. The land costs refer to purchasing the land itself, whether it is an existing building or new plot of land.
Typically, development lenders can allow you to borrow up to 100% of the build costs (including new builds) and then 50% of the value of the land. Overall, lenders will generally lend up to 50% of the gross development value.
Development finance example
A developer has planning permission to build four houses with the gross development value (GDV) estimated at £10 million. The total costs involved are £6 million, made up of £3 million for purchasing the land and £3 million in build costs. A lender might agree to development finance of £7.5 million (limited to 75% of costs) structured as £1,000,000.
There is usually initial advance followed by the balance in stages throughout the build and this helps to maintain a healthy cash flow during the project to pay for various contractors and other fees. (Source: Regentsmead)
What are the fees involved?
Interest rates start at 6.0% per annum, although this will vary from lender-to-lender and other factors such as loan-to-value, security, credit history and affordability. Additional fees are involved when buying and building a property such as broker fees (2%), commitment fees (2%), valuation fees, solicitor fees, stamp duty and insurance.
Commitment fees are usually paid in the early stages of the application process as way of the borrower showing their commitment to the lender.
There are different repayment options available and whilst some make monthly repayments, the majority of borrowers tend to roll over all their interest repayments until the end of the loan term, so they can repay their loan upon exiting the deal (sale) or when they have refinanced.
How is it different to bridging?
Very close to development finance is bridging finance, which is used to complete on a loan where there is a strict deadline and a mortgage would otherwise take too long.
A common example is when you are looking to move house but have not sold your original house yet. You are able to release the equity secured on your existing home and then you have up to 24 months for your first home to sell and then you can repay your loan.
To distinguish between development and bridging, it is common to look at how ‘heavy’ the renovation is. Bridging is used for purchasing the property, but development finance is better suited to making renovations such as light refurbishments, rebuilding or starting a new property from scratch.