How does development finance work?

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How does development finance work?

6 November, 2018

What is a development loan?

A development loan is a short-term funding option, usually for between 6-18 months. It is designed specifically to assist with the purchase costs and build costs associated with a residential development project. This can be a new build, conversion or refurbishment covering a single unit through to multiple units built across a number of phases.

A development funding package invariably involves two key parts to the loan. The first element of the funding will often be used to assist with the purchase of the development site. This could be land where a number of new properties will be built or an existing property that will undergo a refurbishment. The second stage of the loan is used to pay for the costs of the build works associated with the project.

This secondary part of the funding is usually drawn in stages, as opposed to being accessed in one amount at the outset. This often happens once a month as works are completed on the project.

Depending on the type of project, the experience of the developer and the level of build costs, drawdown of the build element of the development finance will be subject to independent monitoring surveyor (IMS) sign off. The IMS will act as the ‘eyes and ears’ on the project for the Lender to make sure works are progressing on time and on budget and will flag any potential issues. They will be acting for the Lender, but their costs will be payable by the borrower.

Build works can be undertaken on a self-procurement basis or via a main contractor under a fixed price contract.

The amount of funding that can be provided will be determined by a professional valuation report that will provide 3 key numbers:

  1. current value – i.e. the value of the site with planning or the value of the property before refurbishment;
  2. the build costs; and
  3. the gross development value – i.e. the value of the completed property(s) assuming all works have completed.

Each lender will have their own lending parameters that dictates the maximum that can be lent.

MSP Capital will lend up to 70% of the current value and 100% of the build costs. Each deal is assessed individually but the funding must be structured in a way to make sure there is enough funding in place to complete the build in its entirety.

The lender will charge fees and interest for the Loan with the amount of the charges depending on:

  1. the amount borrowed;
  2. the percentage borrowed against the overall costs – i.e. the current value and build costs combined; and
  3. the term the loan is required for.

The terms are then detailed in an Offer of Finance, which once accepted will allow the Lender to formally begin the lending process.

The mortgage and loan paperwork will then be dealt with by the Lender’s and the borrower’s solicitors.

Once all formalities are completed, the initial funds towards the purchase of the site can be released to the borrower with the remainder released in stages against works completed and usually signed off by the IMS.

Repayment will be expected before the agreed term has expired from the sale of the completed property/properties, although an extension will sometimes be permitted to provide an additional window in which to secure the sales, subject to additional fees.

Property development loans explained

A secured loan to help with the purchase of a property or land and to provide the build costs for the project.

Various types of developments from simple refurbishments and renovations to large new-build house projects are eligible for development finance.

Often the site will have to have planning consent (by law) although sometimes a version called ‘Permitted Development’ is required. These are obtained from the local council who will often advise applicants about their options and the council’s requirements.

Lenders will normally cap their lending against the value of the finished project (known as the Gross Development Value) and will provide only a certain percentage of the purchase price.

The most conservative lenders in this sector are the high street banks. Alternative and specialist lenders will often provide more debt to their clients.

Generally, loans are agreed for between 6-18 months depending on how long the project will take to complete and how long the finished properties will take to sell.

Once a project is up and running the build loan is drawn down in stages (usually monthly) with the amount of each drawdown equating to the value of works completed in that month.

Loans are secured, usually against the site/property in question, and normally through a first legal charge/mortgage.

The vast majority of development loans are provided for residential properties although occasionally, and in certain circumstances, a loan can be for ‘mixed use’ or wholly commercial use purposes.

Property development finance options

MSP provides fast, flexible development finance tailored to suit the borrower’s requirements and the type of development being undertaken.

Funding can be provided to assist with the simple conversion/refurbishment of existing residential dwellings, to the more complex multi-phased schemes where multiple units are constructed over a longer period of time.

Most development loans will be for a period of up to 18 months, but this will be very much dependent on the nature of the scheme being funded. A straight forward refurbishment loan may only be required for 6 months, whereas a multi-unit new build may require 18 months. The term of the loan will allow time for the property to be purchased, developed and then sold or refinanced to repay the debt.

MSP will fund all types of residential development including houses, flats and conversions of listed buildings and permitted development of offices into residential.

In some instances, development of commercial properties can be considered.

MSP will look to provide up to 70% of the land value (confirmed by RICs valuation). If this is higher than the purchase price (e.g. where value has been added via a planning gain) MSP will recognise this and fund accordingly. Many mainstream lenders will not take this into consideration.

MSP will then fund 100% of the development costs. These can include the core construction costs, professional fees and other expenses such as S106/CIL (Community Infrastructure Levy) payments.

All funding including interest and fees will need to be within 70% of the gross development value.

Each loan will be bespoke to fit the borrower’s individual requirements and in most instances the build loan element of the facility will be drawn upon certification from a monitoring surveyor. By drawing in tranches following completed works, loan interest is only payable on the amount drawn at any one time.

MSP will often allow ‘equity releases’ when sales of completed units occur that can assist with cashflow where a number of other lenders will require 100% of net sale proceeds.

Allowing a cash release often enables clients to move on to future projects in a timelier manner and does not result in equity being tied up in an unsold property.

For further information about development finance, please contact the team at MSP Capital on 01202 743400.