Find out more about our non-exec director, Tim Noble. He’s keen to share his 30+ years development finance experience with you.
Phasing a property development is financial engineering at its best. We’ve crunched the numbers to show how you can maximise equity and scale-up more quickly.
Cash flow, as well as stretching your equity, is king if you’re a developer. And while it may take longer to build out a phased scheme (and potentially losing some economies of scale during the construction phase), if you’re trying to maximise equity, it’s difficult to beat the multiplier effect of a phased development.
Phasing a development is only possible when you have houses or multiple blocks of flats (one block of flats doesn’t work as it all has to be delivered at the same time).
With no minimum number of units required, 16-20 is enough for two phases (or less if they’re larger, executive homes). Phasing is typically used when there are 20 units or more.
- Let’s assume a development of 60 units with a GDV of £ 18m (£ 300k per unit)
- Build costs of £ 175k per unit (£ 10.5m total + 7.5% contingency = £ 11.287m)
- Land costs of £ 2.15m (£ 2m land purchase cost + £ 150k purchase costs)
- Build term of 20 months and loan term of 30 months (10 months to sell)
But if we break down the site into two phases of 30 units;
- 30 units GDV of £ 9m
- Build costs of £ 5.25m
- Land cost of £ 1.15m (50% of the land cost + 100% of the £ 150k land costs – land cost is still £ 2m though, I hear you say – more on that below)
- Build term of 10 months and loan terms of 16 months (six months to sell)
However, the land price is still £ 2m so how do we deal with that? If you have a good relationship with the vendor you could see if a deferred land payment or overage is possible – more info on that here – 7 ways to stretch your equity further
A deferred land payment means partially paying now for the site and funding the difference later. Most lenders allow landowners to take a second charge.
Alternatively, if your vendor doesn’t agree to a deferred payment, you could split the title and take a bridge on the remaining land for phase two, reducing your equity.
In our above example, the remaining parcel of land for phase two is worth £ 1m. With full planning permission, a bridge of 70% (gross) should be possible. The net loan amount would be circa 60% of the land value, so £ 600k (so only a £ 400k deposit). The bridge remains in place until you’re ready to mobilise phase two, at which point you can convert to a development loan (and even reduce your debt by using the sales’ proceeds from phase one).
The net result is the site buyer now only needs equity of between £ 1.16m (£ 758k + £ 400k) and £ 1.77m to buy and build the site, compared to £ 2.28m and £ 3.14m if purchasing as one phase.
This is an equity saving of between £ 1.12m and £ 1.37m; financial engineering at its best.
Ultimately, it’s about maximising the structure’s debt element and reducing the equity portion. Debt is almost always cheaper than equity, so by minimising your equity, you maximise your profits, enabling you to run bigger sites sooner, or multiple sites at the same time.
It also reduces the need for more expensive investor monies and expensive profit shares.
In addition, breaking the project into smaller chunks may make it easier to fund. We recently had an example of a borrower who built three previous schemes; three units, four units and then eight units. The borrower is now purchasing a site with planning for 42 units.
On paper there are probably very few (if any) lenders that would fund them on a 42 unit scheme in one go; eight units to 42 is too big a jump. However, when separated into two phases – 20 and 22 units – the vast majority of lenders will view this as a natural progression.
Phasing, therefore, not only preserves equity, allowing you to scale more quickly, it also helps overcome concerns lenders may have about your development experience if you’re looking to move to much bigger projects as a business.
The next time a bigger site comes up, don’t dismiss it and think I’ll do this in five years, take a look at it in more detail today.