Property Development Loans

It’s very similar to a bridging loan, but with a couple of key differences. The first is in the way that funds are released. With a bridging loan, you take the full capital amount as soon as you sign the agreement. This is because bridging loans are often used to make one off purchases, such as buying a property at auction.

Development finance on the other hand is released in stages, with new tranches being drawn down at key points in the development. The first stage will normally be to purchase land or a building or collection of buildings for renovation. This could be a simple refurbishment or significant restructuring or conversion. This tranche of funds may also include some initial construction costs.

Before each new tranche of funds is released, the lender may want to carry out site inspections. The point of these inspections is to monitor progress against the plans submitted as part of the original application. The lender will want to check that the development is on target both in terms of how long it is taking and how much money is being spent. The lender will want to be happy with both of these factors before releasing the next chunk of money.

Property development loans can take longer to arrange than bridging loans as they tend to involve larger amounts and more complicated requirements. They are well suited to £1 million projects and above - residential, commercial and semi-commercial. Some lenders make development loans as large as £1 billion.

What this means in practice is that you are not expected to repay any of the capital amount of the loan until the end of the term.

It does mean though that the loan will accrue interest throughout the term, and as the capital isn’t reducing as it would in a product like a personal loan or mortgage, the interest can quickly accumulate and become expensive. That’s one reason why development loans are only ever a short-term finance solution - the cost would quickly become prohibitive if they were taken out over the same period as a mortgage.

Interest rates on development loans are normally quoted on a monthly basis, so look out for this - you’ll need to scale up if you want to compare loans based on an annual equivalent. Rates can be relatively high on development finance too, depending on how much you’re borrowing and for what purpose. This is because giving out huge multi-million pound loans to finance building projects is very high risk, and lenders are always going to get their money back.

When it comes to paying back interest, there are different paths you can take depending on cash flow priorities. The cheapest overall way to manage interest on a property development loan is a model called ‘serviced interest’. This is where you make interest payments every month, keeping the balance of the loan at the capital amount throughout.

To give a very simple example, let’s say you took out a £10 million property development loan at a monthly interest rate of 0.5%pm. Every month you’d pay £50,000 in interest and at the end of the term the balance to pay would still be £10 million.

If cash flow is an issue, as it often is in this sort of large scale development, a more popular way to manage the interest is to let it roll up every month. This means that every month an amount of interest will be added to the balance of the loan and the following month interest will be charged on the capital and the interest accrued to date.

If we go back to our original example, the first month’s interest payment would be £50,000. This would be added to the balance, giving a new total of £10,050,000. The following month, 0.5% would be charged on £10,050,000, giving an interest payment of £50,250 and a rolled up balance of £10,100,250.

This rolled up interest model is by far the most common option. If you want to pay your interest monthly, you may need to undergo some further affordability assessments, as lenders will want to look not just at your ability to repay the loan at the end of the term, but also your ability to make significant payments on a monthly basis.