Bridging Loans for property development

Your funds will be released in stages throughout the project term, and will be agreed with the lender before you start. A typical structure would be an initial release of funds to purchase land and pay for the first stage of construction, and then further funds released at various stages of the build.

In order to ensure that the project is going according to plan, you’ll be subject to regular site visits and progress reviews. These will occur before each new tranche of funds is released to you.

The benefit of having funds released in stages is that you will only be charged interest on the funds you’ve drawn down from your loan facility. This makes it a cheaper way to borrow than a bridging loan, where you pay interest on the entire loan amount from day one, even if you don’t spend the money until further into the term.

One of the most important things to consider when choosing development finance is how much it’s going to cost. There are three main elements to this - the arrangement fee, interest rate and exit fee.

These rates are often expressed as a combination of all three, for example - 2% in, 0.6% pm and 1% out or, expressed as an annual interest rate, 2% in, 7.2% pa and 1% out.

Let’s break that down and look at how each of these three cost elements work.

Arrangement fees

This is a fee charged at the beginning of the loan in return for setting up the loan facility. It is charged as a percentage of the loan amount, normally between 1% and 2%. Arrangement fees are sometimes also known as facility fees. Arrangement fees are usually added to the capital loan amount and repaid at the end of the term. This means that you will be charged interest on them for the duration of the loan.

Exit fees

Most but not all development loans attract exit fees, in a similar range of 1% - 2%. Exit fees are charged at the end of the term of the loan and so interest is not payable on them.

Both arrangement fees and exit fees can be based on the net loan value, gross loan value or gross development value (GDV). The GDV is the projected value of the development on completion and so can be significantly more than the value of the loan. It’s important to check on which basis these fees will be calculated so that you are clear about what they are going to cost you.

Interest rates

All development finance is interest-only, so you don’t repay any of the capital until the end of the term. Interest is charged throughout however and for cash flow purposes is normally added on a monthly basis to the loan rather than being paid off every month. This means that interest is charged not only on the capital but also on any interest accrued to date.

Let’s look at an example of what this compound interest might look like in real life. Let’s say you take out a £10 million development loan at a monthly rate of 0.8% pm with a 2% arrangement fee. The fee would be £200,000 and this would be added to the loan at day one, making the capital amount now £10,200,000.

The interest would then be charged and added every month. As you can see, the interest payable every month increases as the balance of the loan increases over a 12 month period:

As you can see, the compound interest effect means that the cost of development finance can quickly start to add up. This example is only over a 12 month period, but if it were to extend over 24 months or even 36 months the cost in this illustration would be significant. At the end of the term you’d then also be liable for the exit fee on top of these interest charges.

You will notice interest rates on development finance expressed as either a monthly rate or an annual rate, depending on the lender. It makes sense to choose the most relevant verison for you and to convert all rates to this for easy comparison, either by multiplying or dividing by 12 as appropriate. For example, a monthly rate of 0.8% per month would become 0.8 x 12 = 9.6% per annum. An annual rate of 7.2% would become 7.2 / 12 = 0.6% per month.

On top of the interest you’ll be charged and the arrangement and exit fees, there are other costs you’ll need to include in our budgeting. This can vary from lender to lender depending on your circumstances, so check the details of all the costs before you agree on a particular product - you don’t want to be caught out with any hidden surprises once it’s too late. A lot of these costs will also increase relative to the size of the loan rather than being a flat fee.

Some other costs to consider include:

• Broker fees - These may be an upfront cost, or you may only pay if your loan application is successful. Some brokers don’t charge anything at all to the borrower, but instead make their money through commission payments from the lender.
  
• Valuation fee - In order to assess the return on the investment and the likely value of the completed project your lender will want to carry out an independent valuation.
  
• Non-utilisation fees - You may find some lenders will charge a fee linked to any funds yet to be released.
  
• Legal fees - You’ll need support from a solicitor to process the loan, so these are an important cost to factor in.
  
• Surveyor fees - Your lender will use a surveyor to conduct a review of your progress at regular intervals, normally before each chunk of money is released. You may see this referred to as a monitoring fee.
  
• Drawdown fees - Every time you draw down an extra trance of money you may well be charged an admin fee to process the payment.

Development finance can be a hugely complex form of borrowing, catering to large scale, multi-faceted projects. As such, a wide range of factors are going to come into play when it comes to how a lender will decide the rates and terms to apply to your finance facility. Some of these you might be able to influence, others will be outside of your control, but it’s still useful to have an idea of how they work together to impact your eligibility for a development loan and the rates you’ll be offered.

When looking at each of these influences, it’s helpful to think about them all in the context of risk. For a lender, everything comes down to risk, and throughout the assessment process they will be using risk as a framework to help them decide whether or not to offer you a loan. Anything that makes you more of a risk and makes it feel less likely that they will get their money back will increase your chances of having your loan declined or increase the interest rate you’re offered.

How much you want to borrow

Whether you’re looking to borrow one million, ten million or one hundred million can have a big impact on the interest rates that you’re offered on your development loan. You may find that very large loans qualify you for a lower interest rate because the lender can make more money from the loan.

The purpose of the loan

The type of development you’re undertaking is going to impact the rates you’re offered and as such should also influence the specific lender you approach for funding. Building a new build housing estate from the ground up is a very different proposition for example to buying and renovating a hotel complex - each will come with different risks and different lenders will be most open to each.

How long you want finance for

This will be determined by the type of project you’re undertaking, but development finance will have restrictions in the length of the term, normally between 3 and 36 months. Typical term length is around 12 months, and different lenders will impose their own limits so it’s a good idea to shop around if you’re looking to secure a shorter or longer than average term.

How much deposit you have

The amount of deposit you have, often expressed as the loan-to-value ratio or LTV, is often one of the key factors that limits how much you are eligible to borrow and the rates you qualify for. The higher your deposit and correspondingly the lower your LTV, the lower the interest rates you will normally be able to get.

Most development finance lenders will be looking for a deposit in the region of 30-40% but if you don’t have this much then don’t panic, it is possible to secure higher LTVs from some lenders if you have other assets to act as security. In some cases you may even be able to fully fund your project with 100% finance.

Your development experience

As you can imagine, a development project being proposed by a first time developer with no experience is going to present as a much riskier option to a lender than a developer with many years of experience and numerous successful developments under their belt. Evidencing your experience as a developer to lenders is one way to help increase your chances of getting the finance you need and getting the ebay possible interest rates.

Your exit strategy

When it comes to assessing whether or not you will be able to pay back the loan at the end of the term, your exit strategy is absolutely pivotal. Put simply, your exit strategy is your plan for how you’re going to pay back the loan at the end of the term, and your lender will want to see that you’ve got a clear and viable plan. In most cases an exit strategy for development finance is either going to be refinancing or selling the properties you’ve developed.

Your credit history

If you have a history of failed projects, loan defaults or even bankruptcy, then it should be obvious that this is going to impact your chances of success when it comes to securing development finance. A bad credit history is a big red flag for lenders, but it may not be a deal breaker, it could be just a case of adjusting your approach and making sure you go to the right lender.

The best thing to do if you want to make sure your credit issues don’t stand in the way of getting a loan is to make sure you have as much information as possible about your credit history before you start. You can do this by getting copies of your credit reports from each of the three main credit reference agencies in the UK - TransUnion, Experian and Equifax. Share everything you find with your broker so that they’re in the best position to make sure they approach the most relevant lenders and can still get you a good deal. You’d normally expect to pay slightly higher interest rates on development loans with bad credit but having a higher deposit and a good amount of development experience can help to mitigate this.

One of the easiest ways to make sure you get the best interest rates on development finance is to work with a broker who specialises in this type of borrowing. You could have a great deposit and years of development experience, but if you don’t have the time for extensive research or easy access to the whole of the market to compare lenders then you won’t be able to guarantee you’re seeing the best deals.

A good independent development finance broker will have this whole market access and be able to compare rates and terms across all the lenders who are appropriate for your needs. You may also find that large, specialist lenders will only work through a financial intermediary and won’t consider direct applications. It’s crucial therefore if you don’t want to exclude yourself from any lenders before you even start that you find a broker who can be this middleman for you.

Getting a large property development loan isn’t simply a case of heading down to a high street bank and filling out a quick form - it’s a high risk form of lending and therefore attracts more specialist lenders than if you were just trying to get a residential mortgage.

Let’s have a look at your options when it comes to the types of lenders offering development finance.

Bridging loan lenders

Development finance is very similar in a lot of ways to bridging finance so you’ll often find that the lenders offering bridging loans will also consider larger development loans. Because of the larger amounts involved, it will mainly be the larger lenders that are in play here.

Specialist property development finance lenders

This may well be the market you find yourself in, as these lenders are specifically geared towards supporting borrowers through development finance. There will be a lot of variation here and you may not find it easy to find and compare lenders. It certainly isn’t as simple as doing a quick Google and comparing high street mortgages. Your broker will be invaluable in helping you access all the information you need on lenders, terms and rates.

High street banks

As previously mentioned, development finance is a high risk form of lending and doesn’t typically fit into a high street bank’s cautious approach to lending. That said, if you are a very experienced developer with a large deposit - i.e. you are low risk - you may find some high street banks prepared to lend to you, depending on the amount you’re looking to borrow.

Remember that you don’t have to worry about choosing the right lenders if you’re using a broker as they will be doing all of the research and shortlisting on your behalf. Nobody expects you to be an expert in funding your project as well as planning and managing it.

Challenger lenders

At the opposite end of the lending spectrum from your classic high street bank are the challenger banks - high risk, flexible lenders who aren’t afraid to take on more complex projects and take more risk. These types of lenders could be appropriate for you if you have a higher LTV or are less experienced. Be prepared to pay slightly higher interest rates in return for this more open-minded approach.

While development finance has a lot of benefits, it may not always be the best form of funding for you and it’s important to consider your full range of options before you commit. Your broker will be able to help you talk through the alternatives to help you decide which method of funding might be the right one for you, but to get you started we’ve picked out a few ideas you can explore before taking the plunge.

Equity release

If you already own property then it may be possible to refinance one or more of the properties in your portfolio to release equity for your new development project. You’ll need to have enough equity available, so you will be limited in how much cash you can free up, but it’s worth considering.

Bridging loan

One common alternative to development finance is a more traditional bridging loan. The key disadvantages to a bridging loan over a development loan are that there tend to be lower limits on how much you can borrow and the funds will be released in one payment, meaning you pay interest on the full amount from day one. You may be able to arrange a hybrid solution, combining a bridging loan and a development loan, which could give you the flexibility you need at a lower cost.

Auction finance

If you’re buying land or property for development at auction then it might be that a specialist auction bridging loan makes more sense for you. You’ll need to consider here how much you can borrow and whether it can cover the development costs as well as the initial sale price, but a broker will be able to advise you.

Joint venture development finance

If you’re struggling to get the loan you need because you don’t have the capital or assets to act as a deposit or you lack experience as a developer, it might be possible to secure the capital you want through joint venture development finance, sometimes called JV finance or a JV development loan.

JV finance does require some sacrifice on your behalf however. You won’t have to front any of the costs yourself - the lender will cover 100% of the costs associated with the build - but in return they will ask for a significant percentage share of the profits, often as much as half. Rates may be higher too than for standard development finance, but it’s one way to get funding and the experience you need in the early days or your career.

Unsecured business loan

If you don’t have a deposit or assets to act as security, you may still be able to get up to £500,000 in some cases as an unsecured business loan to pay for the purchase of land, renovations, refurbishments or business equipment. You’re more likely to need to have a good credit rating to get an unsecured loan, as the lender doesn’t have any assets backing the loan, and you will normally pay higher interest rates too to mitigate the risk

Unsecured personal loan

If your project is only a small refurbishment then it could even be that an unsecured personal loan is appropriate. Normally these sorts of loans are only available up to £25,000, but you may be able to get an unsecured loan for up to £50,000 if it’s through your own bank and you have a good standing with them.

Other alternatives to development finance

Depending on what exactly you’re looking for, there could be many other interesting alternatives worth exploring that don’t fit into the mainstream funding model. These could include, but are not limited to:

• Peer to peer lending
  
• Crowdfunding
  
• Asset finance
  
• Invoice financing
  
• Green finance

Take advice from an independent expert before you make any big financial decisions to help you understand the pros and cons of each form of commercial borrowing.