We explain how to fund a permitted development project, the options available and latest legislation. We also share our experience & lender insights.
Permitted development is a great opportunity for seasoned property developers and investors, but equally for those looking to get into property development for the first time.
Whilst the changing rules for Permitted Development Rights (PDR) have been well documented, less well-known are the various funding options for PDR conversions, and the differences to a traditional new-build property development loan.
First, here’s a quick recap on the recent changes…
What are Permitted Development Rights?
Permitted Development Rights (PDR for short) are the rights of property owners to make changes to a building without asking the local authority for planning permission. Developers must still seek ‘prior approval’ from local planners for some aspects of a development.
What are the new permitted development rules?
- In 2013, the Government granted a temporary PDR allowing a change of use from office to residential accommodation and three years later, this became permanent.
- In August 2020, a PDR allowing upwards extensions of one/two storeys to commercial and residential properties was approved
- In September 2020, the conversion of a wider range of commercial/retail premises (Class E) to mixed-use was permitted
- In August 2021, a new PDR, for conversion between Class E and Class 3 (residential) use was introduced (known as the Class MA right).
What development experience do I need for permitted development?
"Previous development experience is always preferred and is mandatory for new-build loans. However, with permitted development the perceived risk for lenders is lower, and therefore a lower experience threshold is acceptable."
New construction is always the biggest risk in any development, so by removing that risk, lenders are better protected.
Whilst there is a spectrum of PDR, the majority are internal fit-outs or heavy refurbishment, so you don’t need the same skills as a team would if building from scratch. That said, no lender is going to lend to a completely inexperienced team.
If you have zero experience, you need to bring experience in. At the very least, a lender will expect to see an over-qualified contractor or project manager as part of your team, and potentially a profit share or performance incentive.
You may feel reluctant to do this but incentives ensure strategic alignment; a bonus paid if a scheme is delivered on time and on budget, will make the lender far more comfortable.
Whilst you may initially feel uncomfortable giving away a profit share, if you don’t have the experience, you don’t have the grounds to be greedy. Remember you’re not going to retire on your first scheme. It’s a stepping stone to bigger and better things.
How do I fund permitted development?
The key difference between permitted development and new-build, is the weighting between build cost and land costs. The majority of new-build projects are either (roughly) equally weighted, or the build costs are higher than the land costs. The reverse is very rare.
With permitted development the reverse is almost always true; land costs are greater than build costs. This is significant for two key reasons;
- Because of the way development loans are calculated
- Because of the way PDR sites can be valued
Why does this matter?
Taking the first point, and as we touched on earlier, lenders determine a gross loan first, and from there they deduct all of their forecasted lender costs (interest, lender fees and some professional costs), as well as 100% of the build costs, and the rest goes against the land.
The issue is that the vast majority of lenders will have a day one land cap, which means that even if there is spare capacity in the loan to lend more as a function of LTGDV or LTC, the cap prohibits any further borrowing. This invariably leads to needing a larger deposit.
Whilst lenders may shout about the high percentage of GDV they offer, very few will tell you that the day 1 land cap restricts their loans to 60% LTV against the land value.
Like all development loans, each lender will offer to lend a different amount. They will provide a gross loan amount determined by a multitude of factors; the end value, total project costs, equity input, and the day one exposure, as well as geography, loan size, construction complexity and team experience (this isn’t an exhaustive list). The difference between how much each lender will lend can be significant and vary by hundreds of thousands
Worked example 1:
- Lender 1 tells you they lend at 65% LTGDV (loan to gross development value), but they don’t tell you that they are capped at 85% LTC (loan to cost).
- Lender 2 also lends at 65% LTGDV, but they can go to 90% LTC and have no day one loan cap.
On the following scheme, where your land cost is £ 1.8m, build costs are £ 1.2m, lender costs are £250k and you have a GDV of £ 4.5m;
- Lender 1 can lend £ 2.53m meaning a borrower deposit of £ 720k (+ purchase costs)
- Lender 2 can lend £ 2.925m meaning a borrower deposit of £ 325k (+ purchase costs)
A significant difference of £ 395k extra deposit to find on day one.
Secondly, valuers might not value the site the same way as a buyer or seller. Unless you have a permit from the council allowing you to develop, the valuer appointed by the lender will value at a vacant possession value, and not with the benefit of prior approval.
The fact that the permitted development may be a formality is irrelevant. Unless you have the permission notice, the valuer will work on the basis prior approval has not been granted.
It depends on the type of asset, but that could mean that the valuation is only 75% or even 50% of the value if the permission was granted (and the purchase price would have almost certainly been agreed on the basis that prior approval is a formality).
This of course means a bigger deposit is needed as the lender will lend as a percentage of the purchase price or valuation (whichever is lower).
If the lender also has a low day one cap (say 50% or 60% LTV), you could end up with just 30% of the purchase price on day one.
Worked example 2:
If we use the same numbers as above (worked example 1) and the valuer gives the vacant possession value at £ 1m rather than the purchase price of £ 1.8m, then lender 1 can only lend 60% of the day one value (£ 600k). This would reduce the total loan available to
£ 2.05m, and increase the deposit from £ 720k to £ 1.2m (plus purchase costs).
It’s this lack of awareness around this development finance policy nuance that scuppers a lot of would-be property developers plans.
A way to sidestep this is to option the purchase and get the land owner to apply for the permit, and then complete only when the permission is granted. This can of course lead to the owner expecting a premium, or thinking he/she might do it themselves.
Which lenders fund permitted development?
Most bridging and development lenders will fund permitted development projects. Which lender you use will depend on the complexity and size of the scheme. If the development involves any new build element, extension, or addition of another storey, or is bigger than four units, it is better to use a specialist development lender.
How should I choose a lender for permitted development?
Use a specialist development lender if;
- The end property is going to be more than 4 x units
- There is any element of new-build to the project
With PDR there are more options than with new-build. The majority of bridging lenders are happy to support conversions, whereas not as many will support new-build. Almost all development lenders will support permitted development, but will often demand a minimum loan amount of £ 1m- £ 2m.
The bigger the project, the better it is to use a specialist development lender. Whilst some bridging lenders can be perfect partners for conversion projects, the majority are unlikely to have the breadth and depth of experience to support a bigger project. This means if something goes wrong, it’s unlikely that they’ll prove as supportive as you would have hoped.
It’s all too commonplace; when faced with problems with the development, an inexperienced lender is rustling in the drawer for their security papers, looking to find any sign of a covenant breach. The development lending veteran is more likely to offer calm, proactive support, which when a development hits a hiccup, shouldn’t be underestimated.
If you're looking for more information on PDR or development finance more generally, for yourself or your clients, please get in touch - email@example.com.