- 1 Finance your Property Development
- 2 Understanding Property Development Finance
- 3 Bridging Loans
- 4 Permitted Development Rights (PDR) – How do they work?
- 5 Long term Commercial Mortgages
- 6 Funding a Development from the ground up
- 7 Buying a property at auction
- 8 Building a Buy to Let empire
- 9 Buying land
- 10 Peer2Peer and CrowdFunding Property Development Finance
- 11 Property Development Finance Lenders
- 12 Fees, interest and other associated costs of a development or bridging loan
- 13 Bridging Loan Calculator and Yield Return Calculator
- 14 Solicitors (the legal process)
- 15 Conveyancers (getting your property or land valued)
Finance your Property Development
Investor, property developer, entrepreneur…Whichever way you classify yourself, there are a range of finance options that will allow you to fund your next big project.
Borrowing money can be difficult and as banks are still not lending, knowing which alternative lenders to approach is key, so we have broken it down into stages below.
Understanding Property Development Finance
Quite often, bridging finance and development finance are considered the same thing and in some ways they are. However, with development finance there is usually more extensive planning and building work undertaken but we will explain the differences between the two.
In a nutshell, anything which involves the purchase of land, the building of a brand new property (commercial or residential use) or the demolition of an old property and building of a new one is defined as being a property development project.
Most development projects are funded over a 12 month period, with some lenders even providing 18 month development finance deals and they allow you to borrow cash to purchase land and to build on that land.
Once the project is finished, the lender will look for their loan to be redeemed (paid back) and will expect the developer to either sell the finished properties or to re-finance them on to a long term commercial mortgage.
As bridging and development loans are usually only available for a maximum of 12 months, you will need to move your finance to a long term lender who offer commercial finance mortgages up to 25 years.
If capital appreciation isn’t the number one concern for the developer (quick build and profit from a quick sale), then letting the property out is the most viable option as this will allow your property to appreciate in value over time.
As the property increases in value over time, your equity (the available cash in the property less your mortgage) will also increase. As your available equity increases, you may be able to leverage this and raise money against your property to buy more properties and build a property portfolio as a Buy to Let landlord.
Bridging finance is similar but usually involves purchasing a property quickly because of time restraints and then quickly flipping it (selling it) without you having done much work to it but making a significant profit nonetheless.
Commercial Bridging Loans
This is for things like offices, warehouses, shops, etc. Usually, there is a lot more needed on a commercial bridging loan than just a quick lick of paint and in most cases, a commercial bridging loan will morph into a development finance project because of the sheer amount of work needed.
Residential Bridging Loans
The typical scenario for a bridging loan is this: Vendor (seller) wants to sell their house to move on to somewhere new. They find the new home of their dreams but are struggling to sell their own home. The vendors realise that they will lose the new house if they don’t sell theirs quickly so they turn to bridging finance.
They borrow money from a lender to buy the new house whilst still owning theirs and when their house sells, they can redeem the bridging lender.
This is known as ‘bridging the gap’ and it was this very scenario that kickstarted the bridging loan industry. It’s not cheap and it comes with risks, especially if many months pass by and you haven’t sold your existing property but it has a purpose.
Light refurbishment Bridging Loans
This is where the owner needs to put in new windows or doors, or put fencing up or perhaps a conservatory and a new kitchen. Nothing really that will involve planning or major building work.
Heavy refurbishment Bridging Loans
Consider heavy refurbishment to be things like extensions, loft conversions, dormer additions or gutting the property. Usually planning permission will need to be sought and depending on the size and difficulty of the job, an architect and project manager will also be required.
It does not however, mean a ‘ground up’ development or conversion of offices into apartments as they are considered to be development projects.
Permitted Development Rights (PDR) – How do they work?
PDR has been a great success. Have a look around, how many empty office blocks do you see in your local town or city?
Probably quite a few and this is what local councils want to avoid so permitted development was introduced to encourage developers to buy these abandoned and often unmaintained buildings and redevelop them into residential living.
The beauty of PDR is that no requirement to apply for planning permission, something which could take up to 12 months under many local authorities and the scheme was introduced by Parliament, not the councils themselves.
However, the various local councils that do allow PDR to flourish (not all do due to planning limits on this type of conversion), also benefit from their residents living in the city and contributing to the local economy through their spending and of course by paying rates.
Imagine an old disused office block being converted into 150 apartments…The council will receive 150 lots of council tax so you can imagine why they like these types of development.
Long term Commercial Mortgages
When your bridging loan or development finance deal comes to an end, you will have to either sell your property or re-finance it and this is where long term commercial mortgages come to the fore. Bridging lenders will usually only offer loans up to 12 months.
Lenders like Aldermore, Santander, Nationwide, Metro Bank and Shawbrook Bank all offer commercial term loans and mortgages from 1 year to 25 years and whereas with a bridging loan you will be paying the lender up to 18% a year, you can usually arrange a long term deal on rates around 5% a year, sometimes even lower.
Funding a Development from the ground up
Usually reserved for experienced property developers, starting a ground up development project will take a lot of time and effort, not to mention cash. You will have to employ the services of an architect, a professional building firm, a project manager and retain the services of a solicitor who understands development projects.
In addition, the lender will also require a valuation from a surveyor that has a deep understanding of complex build projects and a Quantity Surveyor (QS).
The lender will also require collateral warranties on all professionals involved in the build and full step in rights, should they feel that the project is being mis-managed or that they are in danger of losing their funds.
Buying a property at auction
Similar to the scenario of using a bridging loan to buy a new house before you have sold your existing one, auction finance is another reason why bridging finance has become so popular.
It works like this:
You go to an auction and bid and subsequently ‘win’ on the house you have bid on. The auction house will require you to pay a 10% deposit on the property immediately there and then. Thereafter, you usually then have 14 days maximum to complete the rest of the transaction.
As an example:
You win the bid to buy a house at auction for £100,000. You pay £10,000 there and then on your card (10% of the purchase price).
You then need to find finance to complete the rest of the purchase and whilst a high street lender can fund a house sale obviously, they won’t until at least 6 months have passed after purchase.
You could apply to one of the alternative lenders mentioned above who offer long term commercial loans but even with the best will in the world, there is no way that you will ever be able to arrange finance within 14 days…3 months yes but 14 days no. Hence, the only option is a bridging loan which can be completed within 2/3 days.
Building a Buy to Let empire
Many people started off their Buy to Let businesses by renting out their own home to someone else and moving into a new one and on many occasions, a bridging loan will have been used to achieve this.
Limited company or individual?
One of the reasons there is such a distinction is because of changes to the way Buy to Let tax relief changed in 2015.
This change was significant as it removed a Buy to Let landlords ability to deduct the cost of their mortgage interest from their rental income, in other words, to tax landlords based on their turnover rather than their actual profits.
Basically, you have two options if you want to minimise the changes to your profit structure. They are:
- Put your Buy to Let property portfolio into a limited company structure. Ignore the doomsayers who say there aren’t as many lenders that will lend to a limited company, if at least 10 lenders isn’t enough for you then we would say you were doing something wrong. Corporation tax will be payable but that is less than being taxed on your profits.
- You could ask your spouse to take over ownership of your properties but only as long as she/he is on a lower tax rate banding, otherwise it makes no difference.
Potentially, buying land can be one of the best ways to make a lot of money on a property deal. You have probably heard the expression, “they don’t make land anymore” and this is one of the reasons why land prices remain steady, with or without planning permission.
The cost of developing land isn’t cheap and funding a development acquisition can be a complex affair but with the right planning process and development team in place, it can be one of the most lucrative ways of making money on a property deal.
With planning permission
This is pretty straightforward. You buy land that already has planning permission in place and you finance the development, be that a residential housing development, a mixed use development (houses and shops for example) or a pure commercial development like a serviced office or shopping centre.
Most lenders will finance up to 65% of the land acquisition cost/value so on a £100,000 land purchase, the lender will provide you with £65,000 towards the purchase.
Without planning permission
Much more difficult to finance and fraught with risks, both from a lender and borrower point of view. With this type of transaction, you are buying the land with a view to achieving and obtaining planning permission.
Whilst it can present a great opportunity – we have seen deals where land has been bought for £60,000 and been sold on for £270,000 after planning has been granted – it also presents the borrower with a huge risk.
What if planning cannot be obtained? There are no guarantees and if you are unable to obtain full planning permission (not outline), you will then be left with a piece of land that will be pretty worthless.
That said, some lenders will offer up to 50% of the land value as a loan.
Peer2Peer and CrowdFunding Property Development Finance
Peer2Peer lending has doubled in the last 2 years and every day, you read about yet another bridging loan or development finance lender launching their product.
However, the risks can be huge because quite often you are dealing with lenders who may be experienced in web development but who are novices when it comes to property funding.
There is a difference between Peer2Peer lenders such as Thincats and CrowdFunding lenders such as Kickstarter. It is important that as both a borrower and/or an investor that you understand the difference.
Both CrowdFunding and Peer2Peer lending share the same basic tenet which is that a product or products is funded by a pool of individual investors who all invest to share in the profits made by that product. Or so the blurb says.
Some feel that Peer2Peer Lending is too risky and yet many other industry commentators see it as the future of alternative lending.
The difference between the two is usually down to nothing more than the age of the business looking for funding. If it is a new business or in the very early stages of growth then CrowdFunding may be the route for you.
If you are an established business, say a seasoned property developer with experience of significant projects and developments over recent years, then Peer2Peer may be better for you as they are more likely to lend to an established professional with experience of the sector he or she works in.
Property Development Finance Lenders
This is one area where the alternative finance lenders have come to the fore. Most of the large high street lenders are still not lending money and because of this, property developers and professional Buy to Let landlords are having to get their funding from other sources.
However, don’t be fooled by the term, ‘alternative finance’. The lenders in this market are huge and lending volumes of £1bn per year are not uncommon amongst the biggest players, so you can rest assured that your money is in safe hands and of course, they are open to the same level of financial scrutiny as the banks are.
Whilst most alternative lenders will offer bridging finance, not all will offer development finance as this is a highly specialised area.
Fees, interest and other associated costs of a development or bridging loan
Any type of short term lending will come with a cost. You are paying for the speed of completion and risk to the lender and this will be priced accordingly.
One thing to note is that whilst bridging finance can be expensive, the investment into your project could pay huge dividends and like all entrepreneurial developments, you have to balance the risk versus the reward.
You also have to factor in that a bridging loan will usually only be needed for a few months, just time enough for you to refurbish the property and either sell or re-finance.
If you then work out the total cost to you over this period, that is the best way to look at it as it will give you a true picture of your total spend.
On a development finance deal, you will also need to factor in the cost of each drawdown (release) of funds at each stage of the development.
Usually, development funding is done in stages such as day 1 loan drawdown, stage 2, stage 3, etc and every time this happens, there is usually a fee to be paid to the QS (Quantity Surveyor) and the Valuer (Surveyor) for them to agree that the development is at the right stage for funds to be released.
The reason for this is funding for development is done in arrears. This means that the lender will only release funds after they are satisfied that the works in question have been completed satisfactorily and in adherance to the plans.
On a bridging loan you can expect a monthly interest rate in the region of 1 – 1.75% a month and on a development finance loan you can expect a rate in the region of 1.25 to 2% a month.
Rolled up interest
This where the lender will allow all of the interest on a loan to be ‘rolled up‘ and added to the loan which is then only repayable when the property/development is sold or re-financed.
This allows the borrower to continue with a project, aid their cashflow and not worry about meeting the repayments each month and as you can imagine, it is a highly popular way of financing a project.
There will be occasions where a lender will want to deduct their overall interest charges from the loan on day 1. So, if a client borrows £1m and £100,000 of that is interest, the lender may deduct their £100,000 from the £1m loan advance leaving the client with a net loan of £900,000.
Occasionally, they may decide to deduct 3 months interest on day 1 and then roll up the rest but it really it depends on each particular deal.
Lender arrangement fees
Some lenders will charge an arrangement fee of 1% of the loan amount and add this to your loan but on the whole, most lenders charge 2% of the loan.
Again, similar to above however not all lenders charge an exit fee. If they do, it is usually in the 1 – 1.5% region but do avoid any lender that will charge an exit fee above 3% of the loan amount (we have heard of some lenders charging 7% as an exit fee!)
Bridging Loan Calculator and Yield Return Calculator
This can be useful if you are looking to work out your costs on a new project. The rental yield or return on investment figure is the single most important element of any commercial mortgage or Buy to Let investment.
In simple terms, the cost of finance is the amount of money you want to borrow x the interest rate x the term of the loan.
For rental yield, the calculation is as follows:
Annual rental figure (less costs of maintaining the property) divided by the purchase price x 100%. This figure will then give you the net rental yield and is a quick and simple way to determine if your investment is economically viable.
Solicitors (the legal process)
Often overlooked in the whole lending process, the role of the Solicitor is probably the most important. A good solicitor will get your loan over the line and get the project through to completion.
Delays in development projects are usually down to a solicitor not understanding a lender’s requirements and these delays can result in borrowers and developers missing key deadlines.
Tip: Only instruct a solicitor with experience of bridging loans and property development.
Conveyancers (getting your property or land valued)
If you are borrowing money against the value of the land or property you are looking to purchase, then a survey will be required by the lender.
This survey will assess the project and make the lender be aware of any structural problems, demand for similar properties land issues or or other objections which may affect the value of the security (land or property).
If you are looking to fund a development project, particularly the building of a new property on land, then it is almost certain that the lender will also insist on a Quantity Surveyor (QS).