Development Finance: What It Is and How to Get It

What is Development Finance?

Development finance isn’t your average loan. It’s a specialised financial solution crafted to meet the unique challenges of property development, whether that’s residential or commercial. 

Unlike standard mortgages that you would use to purchase an existing property, development finance loans are short-term in nature—lasting anywhere from 6 to 24 months. 

These loans are the key to unlocking opportunities, be it for ground-up constructions, property conversions, or significant refurbishments.

How Development Finance Can Work for You

The beauty of development finance is that it’s designed with your project’s lifecycle in mind. Whether you’re focused on a residential or commercial project, this financial tool is flexible enough to accommodate your plans. 

Traditional mortgages rely on the value of existing properties, but development finance takes a different approach—it focuses on the future.

When applying for development finance, it’s not just about how much it’ll cost to build or renovate. You should also consider the future value of your development—what it’ll be worth once the work is all done. 

Are you building from scratch, or are you planning a significant renovation or conversion? Both scenarios work well with development finance.

Lenders use two primary indicators to assess your loan application: Loan-to-Cost (LTC) and Loan-to-Gross Development Value (LTGDV).

LTC helps them understand how much of your project’s total cost the loan will cover. LTGDV, on the other hand, is all about estimating the loan amount against what the property will be worth when fully developed.

And don’t forget—your past success and your ability to pay back the loan are vital parts of this assessment.

One unique perk of development loans is the ‘rolled-up‘ or capitalised interest.

What does this mean for you?

Simply put, you won’t have to make any monthly interest payments during the construction period. 

That’s right, no draining your cash flow when you need it most. The interest gets added to the total loan amount and is settled either when you sell the developed property or refinance it.

Development Finance: A Practical Example

Suppose you’ve located a plot of land with a price tag of £550,000. You plan to build eight four-bedroom houses. The projected construction cost for all eight houses is £1,800,000. 

The estimated Gross Development Value (GDV) after completing the construction can be calculated as:

• GDV= Price per house × Number of houses = £400,000 per house ×8=£3,200,000

Key Figures

• Land cost: £550,000
• Build cost: £1,800,000
• Total deal cost: £2,350,000
• GDV: £3,200,000

Description	Percentage	Calculation	Loan Amount
Land Cost Loan	65%	65% of £550,000	£357,500
Build Cost Loan	85%	85% of £1,800,000	£1,530,000
Total Loan Facility (The Pool)	–	£357,500 + £1,530,000	£1,887,500

How the Loan Works

• Initial Land Purchase. The lender will provide £357,500 (65% of the land cost), and you’ll need to contribute £192,500 from your own funds to complete the land purchase.
• Construction Phase. The remaining £1,530,000 (85% of the build cost) will be released in phases as construction moves forward. You’ll use your funds first, and then the lender follows with further drawdowns as needed.
• Loan Repayment. Upon selling the houses, you’ll repay the borrowed amount of £1,887,500 plus any accrued interest. Since this isn’t a joint venture, you’ll retain all the profits.
• Interest. Interest is typically only charged on the funds that have been drawn from the loan pool. This way, you’re not paying interest on the full £1,887,500 from the get-go, but only on the funds you’ve used.

What are the Different Types of Development Finance?

There’s no universal financial solution for every development project, as each has its unique requirements. Various types of development finance are available to cater to these different needs. Here’s a guide to help you understand your choices:

• Residential Development Finance – Ideal for projects ranging from a single home to larger residential schemes. This type of finance generally covers everything from land acquisition to construction costs.
• Commercial and Semi-Commercial Development Finance – Suited for projects that involve business premises or mixed-use buildings. This option usually accommodates more complex valuation criteria.
• Land Development Finance – Used for purchasing undeveloped land and preparing it for construction, including obtaining the necessary permits and conducting site improvements.
• Renovation and Refurbishment Finance – Geared toward the enhancement of existing properties, whether it’s a straightforward refurbishment or a more complex conversion.
• New Construction Finance – Ideal for large-scale, ground-up construction projects, covering both material and labour costs.
• Exit Financing – Provides a short-term financial cushion after the completion of your project, giving you time to sell the property or secure refinancing.
• Regulated Development Loans – Required when more than 40% of the development will be a residential space occupied by the borrower. These loans are regulated by the Financial Conduct Authority (FCA).
• Mezzanine Finance – Bridges the gap between the primary loan and the total project cost, offering additional funds to ensure the project’s completion.
• Development Bridging Finance – Useful for quick property acquisitions or auction purchases, acting as a temporary measure before more long-term financing is secured.

Some projects may demand a mix of these finance types. If you’re still uncertain about which financing route to go down, consult a professional. They can guide you through the process, ensuring you choose the best option for your project.

How Do You Qualify?

To qualify for development finance, you’ll need to meet an array of criteria. 

Generally, lenders seek applicants with a proven track record in property development. For those new to the field, a robust team or experienced partners can significantly improve your application’s credibility. 

Your expertise and the presence of certified professionals in your team might also factor into the lender’s decision.

Credit history is another crucial aspect. A clean financial record, devoid of bankruptcies or defaults, enhances your appeal to lenders. 

In addition to a clean credit record, lenders may also look at your existing cash reserves or accessible lines of credit as assurance against unforeseen expenses.

Financial documentation is non-negotiable. Expect to provide an extensive range of details including project plans, cost estimates, projected profits, and timelines. 

You may also be required to submit a comprehensive business plan, market research, and proof of legal compliance. Lenders often request a professional valuation of the property or land you aim to develop.

Many lenders also require some form of security, usually the property you’re developing, another asset, or even corporate or personal guarantees. 

A deposit will also be needed; the amount generally falls between 20% to 40% of the total project cost but could vary depending on additional factors like the project’s location and the level of risk assessed by the lender.

Given that each lender has unique requirements, it’s advisable to consult a mortgage broker specialising in development finance. 

This ensures that you are not only meeting the baseline criteria but are also aligning your application with the most suitable lender for your project’s specific needs.

What You’ll Need for a Smooth Application

Beyond the criteria for qualification, the application process itself involves several steps, all requiring their own set of documents. Here’s what you should have at hand:

• Planning permission and architectural drawings.
• Any planning restrictions that could affect profitability.
• A complete cost breakdown of the project.
• Examples of your past developments, if any.
• A detailed operational calendar.
• Contacts for your architects and contractors.
• A list of your current assets and liabilities.
• Your exit strategy.
• The project’s projected final value.

Even if you’re a first-time developer, don’t worry. There are lending options suited for you as well.

How Much Money Can You Borrow?

In development finance, you have the option to borrow from £200,000 up to £50 million. The ceiling amount will depend on the lender you pick. 

So, whether you’re a small developer planning a quick fix-up or a larger outfit with ambitious plans, there’s probably a loan that fits your financial scope.

To get a handle on what your repayments might look like, give our calculator below a go. You can adjust factors like the Loan-to-Value (LTV) and loan term to see how they change your repayment amounts.

[Embedded Development Finance Calculator]

While the calculator is a good place to start, it shouldn’t be your only reference. It’s wise to talk to a specialist broker who can double-check your numbers and steer you towards the best loan for your needs.

What are the Interest and Fees?

Interest rates for development finance can range from 7% to 16% APR. While you might find these rates significant, keep in mind that these loans are generally short-term. 

That makes the interest rate often less crucial compared to the total cost of the loan, including various fees and terms set by the lender. In short, the cheapest rate doesn’t always mean it’s the best deal for you.

Beyond the principal and interest, there are additional costs you should be aware of, and these can vary depending on your project and loan details. Here’s what to expect:

• Lender Arrangement Fee. This fee is often 1-2% of the loan amount. So, for a £1 million loan, you could be looking at £10,000 to £20,000.
• Broker Arrangement Fee. If you use a broker, they might charge a similar fee of around 1% of the loan amount.
• Monitoring Surveyor Fees. Also known as Quantity Surveyor Fees, these could range from £1,500 to £5,000 depending on the project’s complexity.
• Exit Fees. These vary widely but could be around 1% of the loan’s total value or the gross development value.
• Legal Fees. Expect to pay around £2,000 to £5,000 for legal costs, including solicitor fees.
• Non-utilisation Fees. These are less common but can be about 0.5% of the undrawn loan amount per month.
• Management/Admin Fees. These are usually nominal, perhaps a few hundred pounds, covering the lender’s administrative costs.

It’s crucial to look at the full picture when evaluating loan options, considering both the interest rate and any additional fees. Consulting a mortgage broker specialising in development finance can offer further insights tailored to your situation.

Full Financing for Your Project

In the UK, most development loans typically cover between 60% and 80% of your total project cost. However, if you’re looking to cover all your project expenses, there are ways to achieve 100% financing. Here’s how:

1. Joint Ventures: Pairing up with a financier could enable you to cover the full project cost. In this setup, the financier would provide the funding in exchange for interest payments and a portion of the project’s profits.
2. Extra Collateral: If you’ve got additional assets, like more property or even valuable equipment, you can offer these as extra security to get a loan that covers 100% of your project costs.

Important Note: Both options come with their own set of terms and conditions. It’s crucial to weigh these against your project needs to see which route is more advantageous for you.

Understanding Commercial and Residential Development Finance

When you’re diving into a property development project, you’ve got two main types of development loans to consider: commercial and residential. 

But what sets them apart? Here’s a breakdown:

Commercial Loans

• Purpose: These loans are aimed at developing properties for business use or mixed-use, combining business units with residential spaces.
• Maximum Loan Value: You can usually borrow up to 70% of both land and build costs.
• Loan Term: These are short-term loans, lasting from 6 to 24 months typically.
• Interest Rate: Expect rates to fall between 4% and 15% APR.
• Regulation: Generally unregulated.
• Exit Strategy: Once your development is complete, you can either sell the property to repay the loan or retain and lease it out, transitioning into a long-term mortgage.

Residential Loans

• Purpose: Perfect for developing properties primarily for residential use, like single homes or a handful of units.
• Maximum Loan Value: You can often secure up to 70% for land and 90% for build costs.
• Loan Term: Like commercial loans, these are usually short-term, ranging from 6 to 24 months.
• Interest Rate: Rates typically range from 4% to 15% APR.
• Regulation: May be regulated if more than 40% of the completed project is for personal residential use.
• Exit Strategy: Similar to commercial loans, you can sell the property to repay the loan or keep it and lease it out, eventually shifting to a long-term mortgage.

To further differentiate the two, commercial developments typically necessitate a comprehensive sales and marketing strategy. This is because the end goal for most commercial developers is to sell the completed property. 

On the other hand, residential developments generally require less aggressive marketing, which often makes securing a loan for such projects more straightforward.

What is Development Exit Finance?

Development exit finance serves as a bridging loan that you can take out after your project is complete but before it’s sold or refinanced with a long-term mortgage. 

This loan is designed to pay off your initial, costlier development loan, providing a financial cushion until you can sell the property or switch to a more permanent mortgage solution. 

One of the benefits is that the interest rates for development exit finance are often lower than those of standard development loans. It’s a practical way to bridge the financial gap between project completion and your next steps.

How Do You Repay a Development Loan?

You have several straightforward options when it’s time to square up your development loan:

1. Sell and Settle. You can repay your loan in full with the money you make from selling your completed property.
2. Switch Gears with Refinancing. If you’re not in a hurry to sell and want to keep the property for yourself or rent out, consider refinancing with a long-term mortgage. This changes your short-term obligation to a more manageable, longer-term one.
3. Exit with an Exit Loan. Opting for a development exit bridging loan is another savvy move. Not only does it usually come with a lower interest rate, but it also allows you to retain more of your profits as you wait for your property to sell.

Key Tips Before You Dive In

Before you even think about securing a loan, ask yourself these crucial questions to make sure you’re ready for the journey ahead:

1. Why hasn’t this property been sold yet? Is there a hidden reason?
2. Can I stick to a budget? How much can I afford for the property and construction?
3. Have I considered hidden costs? Any surprise expenses I should know about?
4. Are my architects and contractors reliable? Have I checked their references?
5. Do I have a backup plan? What if something goes wrong?
6. How does the property’s value compare? Have I looked at similar projects?
7. Is there enough demand for this property? Will people want it?
8. Who is my target buyer? Do I know my audience?
9. Is the market too crowded? How’s the competition?
10. What’s my projected profit and timeline? When will this project be done and how much will I make?
11. Is my credit score solid? Any errors to fix?
12. Do I have all the needed documents? Am I fully prepared?
13. Can I afford the deposit? Or do I have assets to use as collateral?

If you can confidently answer these questions, then you’re well-prepared for the next steps.

The Bottom Line

Choosing the right loan is as crucial as picking the right team for your construction project. The options are plenty—from banks and investment firms to specialised property lenders. Each has its own set of requirements.

Some may want detailed plans and heaps of paperwork, while others focus on your property’s value and your credit score.

Using a development finance broker can streamline this process for you. They can match you with lenders that suit your project’s needs, negotiate better terms on your behalf, and save you time by gathering and sorting all the required documents.

If you’re ready to make an informed choice, reach out to us. We’ll match you with a development finance advisor to help you make the smartest financial decisions for your project.