How does development finance work?
How does development finance work is a question that we get asked on an almost daily basis.
Because of the way this type of finance is arranged, it can look like it is more complex and difficult than it actually but let’s not forget it’s in a brokers interest to make it more difficult than it actually is because then it means the borrower will have to utilise the services of a broker, rather than going to a lender directly. Even first time developers can obtain finance.
You can also view a number of case studies on our site, this one was for property development finance North Wales.
Okay first things first, what will the lender want to see at the start?
List of required items for a development finance loan application
- Cash flow forecast
- Development appraisal, CV or bio of the borrower or borrowers
- Images or photographs of the security that the borrower is trying to fund
- Sales information on the completed property valuation in the open market
- Details of the exit strategy. This will need to be more than the borrower simply stating their exit strategy is to sell the completed units or refinance to to another lender. The development finance lender will want to have more certainty and more comfort surrounding the exit than just a throwaway line and they may ask to see evidence
- If applicable, planning application numbers or details of the full planning approval decision
- Details of the main contractor, their financial standing and their experience
The lender will assess the loan application in a number of key areas, they are:
The borrower
Will the borrower have the knowledge and experience to complete the development finance project on time and under budget. If not, do they have professionals around them who can help them to achieve this and all these professionals experienced in the type of work that the borrower is looking for them to do. In other words you do not want to be employing the services of a roofer to complete the construction of a three bedroom property as they simply will not have the experience or expertise needed to do this correctly. The lender will insist on seeing details and evidence of recent similar bills that the main contractor has undertaken. For example, if the borrower is thinking of using a main contractor to build a property from the ground up and they’ll need to say that that main contractor has done something similar within the last two or three years because a builder he can only evidence similar bills from 10 years previously will not be acceptable to the lender.
The numbers
Do the numbers stack up? The lender will want to know if the sales price of the completed units (GDP) is achievable in current market conditions and they will use the online property portals and their own internal valuation software to check if this is achievable against what has been said. They will also have their own in-house QS to check that the build costs and overall construction costs (including professional fees from people such as architects, designers and engineers) are consistent with a build of the type and justice importantly, will be costs that the borrower has stated ensure that the build will be finished on time and to a certain standard as that is vitally important. One thing that every lender will also check is to ensure that the borrower is not taking out a salary whilst the building/construction is going on and they will also check to make sure that the borrower is not trying to fund legal fees or selling fees within the total bill costs that they have stated because in the lender will fund these particular items. The interest rates charged by development finance lenders will also have an impact on the amount that can be borrowed.
The security
The development finance lender will rely on the initial valuation to understand the value of the security that has been offered because this is what our lender will base their lending on. When we say value we actually look at a number of different values not just the current open market valuation or OMV. A lender will also need to see the 180 day valuation, the 90 day valuation and in the case of a commercial property such as a hotel or care home, the lender will also need to see the VP or vacant possession valuation. The lender will also look closely at resale values and specifically, how long it will take that property/a security to sell at that price in current market conditions.
How will the loan be repaid
This is probably the single most important point for a bridging lender or development finance lender. Because development finance loans are all over a maximum term of 24 months, these are considered short-term loans and are not designed to be used for a borrower looking to buy or fund a property over the next 25 years.
All lenders in the development finance sector will want to see a clearly defined exit plan on how their loan will be repaid at the end of the term be it three months, six months or 24 months it doesn’t matter, the lender will want to see that the borrower has plans in place to repay the loan on time.
The other important factor in this, is that the lender will want to see that the borrower would be able to refinance to a long-term commercial lender such as a High Street bank like NatWest or Santander, if they’re unable to sell the property. The reason the lender has to ensure that the borrower is a viable option it’s because those long-term lenders will do a credit check and possibly credit score the borrower and if they fail that (due to previous or ongoing adverse credit issues, then the long-term commercial lender will not consider funding them and that means that the borrowers only option to repay the development finance lender is to sell the property.
