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In this article we’re going to look at some of the basics when it comes to development lending.
We’ll look at how they work, what they can be used for, and why a broker is invaluable in helping you secure the very best deals. Before we go into any detail, let’s make sure we understand exactly how property development loans work and how they can be used.
A property development loan is a short-term, interest only form of borrowing, designed to finance large scale building and renovation projects.
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.
The appeal of development finance lies in its flexibility and with the right planning and exit strategy the sky is potentially your limit when it comes to what you apply for funding for.
To give you an idea of the versatility of bridging loans for property development, let’s take a look at just a few of the different ways that it could be used:
From the initial purchase of the land right through to kitting out the show home, development finance is ideally suited and very commonly used for multi-unit residential housing estates.
Maybe you’ve got an old factory in your town that has recently been converted into luxury apartments of various sizes, including those top floor penthouse apartments with the views over the river? It’s very likely that this conversion was funded through development finance.
Whether it’s building a brand new halls of residence from scratch or converting disused office or retail space into accommodation, student accommodation is another great candidate for development finance, with a guaranteed return due to a constant demand for more and more housing for students.
Do you have an area in your town or city that’s undergoing a facelift? Perhaps you’ve spotted old offices being converted into new retail spaces, or a formerly derelict piece of land that is now home to a mix of small shops with flats above them? Development finance can be used for residential, commercial or semi-commercial purposes, making it ideal for projects that involve a mix of homes alongside retail or office space.
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.
This type of finance is considered high risk and so isn’t the sort of borrowing you’ll see being offered as mainstream from the high street banks and building societies. Instead you’ll need to go to a lender who specialises in high value development finance. As most development loans will be unregulated, lenders have a lot more flexibility to consider each application on an individual basis. This means that even if you have a complex project you’re looking to fund, or have any kind of non-traditional circumstances, your application will still be considered.
Because you need a niche development or bridging loan lender, it can be harder to research and compare offers and rates. The best way to find the right lender for you is to use a development finance broker. They’ll have access to the whole of the market and will be able to compare lenders much more easily and quickly than you’d be able to as an individual. Not only can they save you stress and time, but they will also be able to find you the best interest rates for your circumstances.
We hope that this article has given you some insight into the variety of property development loans available
If you’re looking for development finance then your next step should be to get in touch with an expert broker that you trust to handle your application process. MortgageKey has over 2,200 reviews on TrustPilot with an excellent rating overall, so you know that you can trust our expert team. Get in touch today to find out more about how we can help you get the finance you need.
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