The Pros and Cons of Development Loan Finance

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Here at Revolution Brokers, we negotiate a massive range of property finance – and if you’re interested in any of the following, development lending might be an option:

  • Renovating a currently uninhabitable property.
  • Refurbishing a buy to let investment.
  • Converting a commercial business premise.
  • Developing land or an empty site.

Most UK development finance loans are for new builds, conversions and refurbs.

Still, there are many development borrowing products out there, so it’s a broad field and a type of financing applicable in many scenarios! If you are looking to open a business, you can get a small business loan with Credibly.

Here we’ll explain how development finance works, the advantages, and the potential downsides to be aware of.

How Does Development Finance Work?

Property development finance isn’t a mortgage. Instead, it’s a short-term loan to cover the costs of the development work.

Therefore, your exit strategy is key to your application.

For many developers, that exit strategy is to sell the project when the development work is complete, or refinance, perhaps through a buy to let mortgage or a commercial mortgage.

Given the short-term nature of the loan, development finance will always be slightly more expensive in terms of interest rates – but also far more flexible.

Development finance products typically have a 12 or 24-month term – although that depends on the scope and size of the development and how quickly you anticipate the work being finished.

You can:

  • Usually borrow a relatively high LTV against the cost of the property purchase or land cost – often up to 70% but sometimes as high as 90%.
  • Apply for finance for up to 100% of the building or development works themselves.

Most lenders like to see contingencies, both in the project budget and in the completion date.

Having wiggle room means you’re far less likely to come unstuck halfway through, and therefore present a risk for the lender that the exit strategy will be delayed or prove no longer profitable.

Once you have a total budget, plus a contingency, you draw down funding in tranches at crucial stages of the build – i.e. when the foundations have been laid or when the property is watertight.

That means you won’t need to start incurring interest on the entire facility from day one but pay interest on whatever you’ve drawn down so far.

What Are the Advantages of Using Development Finance?

The key benefit to development finance is that it offers excellent flexibility. In many cases, it would be impossible to secure a standard mortgage on a development project because:

  • The property is uninhabitable and therefore unmortgageable in its current condition.
  • The market value of a dilapidated property may be deficient and insufficient to act as security for a regular mortgage product.
  • It can be hard to apply for a mortgage above the purchase value of a low-cost investment property and raise the capital to pay for the development work.
  • You’d need a high deposit value to secure a mortgage on a non-standard property and then still have the issue of raising finance for the project costs.

Therefore, a development finance loan is a great way to secure borrowing on properties, or empty plots of land, that you’d not be able to mortgage.

Even derelict and disused buildings qualify, provided you’ve got a solid project plan, budget and exit strategy.

While some lenders will prefer to work with developers with previous experience, that isn’t a prerequisite across the board.

Revolution negotiates development finance on behalf of residential developers and first-time project managers, so you don’t necessarily need to have a past conversion under your belt to get a new development project off the ground.

One of the other advantages is that you won’t need to pay interest for the duration of the loan term on the total value – in most cases, you’ll pay only against the amount drawn down to date.

Are There Pitfalls to Applying for a Development Finance Loan?

For most conversions or new builds, a development finance loan is far and away the most appropriate solution.

However, there are a few factors to consider:

  • Lenders will need to assess the purchase value of the property or land, how much the development will cost, associated legal and professional fees, and how realistic the building work timescale is.
  • Your exit strategy must be watertight – a lender won’t approve a development loan if they consider there is a risk that the project won’t be worth what you estimate or that you’ll not be able to sell the property at the end of the term.
  • Interest charges range from 4.5% for the most lucrative investments up to an average of 6.5% to 9% for most projects – you must include those costs in your budget to ensure the plan is profitable.
  • Developers need to cover valuation fees to assess the site value at the start and end of the development and possibly during the conversion work.

It’s also wise to note that the lender will carefully assess the work timescale and your requested drawdowns throughout the development project.

Although paying interest only on the capital you’ve borrowed is favourable, some lenders levy non-utilisation fees against the balance of the facility offered that hasn’t yet been drawn.

You will need to schedule time for the inspections and valuations, which lenders typically need to carry out before they agree to release the next tranche of funds.

How Does a Property Valuation Work for a Development Loan?

Given that you’re borrowing cash against a property that is either in a very different condition to the expected end product or hasn’t yet been built, the valuation works a bit differently from a regular mortgage.

Lenders work based on a figure called gross development value – GDV.

GDV is the anticipated value of the property or development when all the work has been finished.

We’ve mentioned the importance of the exit strategy, so you’ll need to ensure you have completed sufficient market research and analysis of local property prices to ensure the GDV reaches your expectations.

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