Development finance is a short-term loan specifically for property developers, businesses and investors looking to take on new construction projects, conversions, or renovations.
Unlike traditional mortgages, which are designed to help people purchase an existing property, development finance more typically covers both the purchase and costs associated with the project as a whole – making it a more flexible option.
Understanding The Basics Of Development Finance
At its core, development finance is a property loan designed to fund construction or refurbishment projects.
Whilst the period of the loan can be flexible depending on the project, it is typically offered based on the projected timeframe for completion.
The funds are usually released in stages to help businesses manage the different phases of the project and also reduce the risk of them paying unnecessary interest. For example, a lump sum may be released to help cover the purchasing of the land or property, with the rest of the funds released once the completion date has passed.
The key difference between development finance and regular mortgages is the amount a person can borrow. With a development finance, a loan amount is based on the projected value of the property once the project is complete. The is known as the Gross Development Value (GDV).
When it comes to a traditional mortgage, the loan is usually determined by a person’s earnings and the value of the property at the time of application.
With development finance, lenders or bridging loan brokers will often work out the Loan-to-Value (LTV) ratio. This is the value of the loan against the overall GDV. They may also look at the Loan-to-Cost (LTC) ratio, which measures the loan against the total project cost.
How Does Development Finance Work?
Development finance works differently from a normal loan or mortgage.
First, the funds are not released all in one go. The first portion of the loan is normally used to buy the land or property that will then be developed. Once this phase is complete, the rest of the funds are normally released in stages as the construction works develop.
This approach not only helps manage risk for the lender, it also ensures the borrower isn’t sitting on unused funds that are compounding interest. Generally, each stage of the project is carefully monitored, usually by an Independent Monitoring Surveyor (IMS), who makes sure that everything is on track and the budget and timeline are being adhered to.
What Types Of Development Finance Are Available?
Development finance isn’t a one-size-fits-all product; there are different types available depending on the project and its specific needs.
For those working on building from the ground-up, there is an option called ground-up development finance. This type of finance is useful for big new build projects and normally involves significant investment at different stages of the project.
For those working on existing buildings, there is also renovation and conversion finance. This is perfect for any project that is turning an existing building into something new.
For developers looking to bridge the gap between completing a project and selling or refinancing it, development exit finance can useful too. This type of finance helps developers pay back the first development loan with a lower interest rate while they wait for the property to sell.
Another option is mezzanine finance, often used as a secondary loan that sits behind the main development finance.
For more information about mezzanine finance, see our guide here.
Each type of development finance has its own pros and cons, so choosing the right one for your project is important!
What Are The Costs Involved In Development Finance?
While development finance can be a great choice for its flexibility, it goes come with a unique set of costs.
The interest rates on development finance loans tend to be higher than standard mortgages, but they are also usually quicker to secure and may be more flexible on terms.
The higher interest rate isn’t always a bad thing, because the loan term is short and interest is paid off quickly, the cost is often more manageable than it first appears. The total cost of the loan will need to be calculated before you sign, but usually depends on factors like the loan amount, how long the project is due to last, and how much is borrowed at different points in the project.
It’s also worth noting that there are a number of fees involved too. If you use a broker, they may charge a fee and the lender may also require some admin fees too.
All these costs should be discussed up front and factored in when planning the budget for the project.
How To Apply for Development Finance
Applying for development finance involves more than just filling out a form. Before you even think about applying, it’s important to map out the entire project and expected costs to ensure the budget is comprehensive.
When applying for a loan, lenders will usually ask for a proposal that runs through how the project will play out, including property details and cost of purchasing, development plans, estimated labour and material costs, and the projected GDV. This helps the lender look at how viable the project is for the loan amount, and assess the risk involved.
Lenders will likely also want to see proof of planning permission, construction plans, and detailed cost breakdowns. The best way to secure a loan is to come with all the information. The lender wants to know that their money is in safe hands, and the more information they have, the more likely they will be to approve it.
The Pros and Cons Of Development Finance
Development finance can be a great tool for property developers. It allows them to access funds and manage their cash flow effectively, without paying unnecessary interest.
Development finance is not just about borrowing money, it is using the loan to bring a vision to life. Whether you’re a seasoned developer or taking on your first project, understanding the ins and outs of development finance can help you decide if it’s right for you.
Need some advice? For business loans visit Blue Square Capital to find out more today.
