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Development Finance London

What is Development Finance?

Property development finance is a short-term loan used to finance the construction, conversion or refurbishment of buildings. Loan sizes are based on four main metrics: gross development value (i.e. what will the site be worth when the development is finished), total project costs, minimum borrower equity and day one land leverage. Once the site is complete, the loan is paid back in stages either through the sale of the property or via refinance.

Development finance news in London

Despite the economic impact of Covid-19, London is still buzzing with construction work as demand continues for housing, leisure and commercial property. From flats and houses, to hotels and offices, development is underway on a vast range of projects across the capital, and developers are taking ingenious approaches to overcoming the distinct lack of space in the city.

There are pressures on the capital to overcome its housing shortage. In 2018, London mayor Sadiq Khan announced the launch of an initiative to boost the construction of new homes by SME property developers. He said that planning permission rules would be relaxed to help SMEs more easily build on small sites in the city. In August 2020, the government also announced a loosening of planning   to make it easier to build properties.

Other planning laws that recently came into force mean up to two storeys can be added to buildings without full planning permission. On top of this, ‘air rights’ (owning the rights to the air above a property that could reasonably be used) are also a great opportunity for developers to build homes – which can then be sold or leased – on top of commercial premises in London’s crowded streets.

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Added to this, ‘build to rent’ is growing in popularity across the capital. Build to   means homes are developed for long-term letting rather than selling to individual owners. The concept comes from the legacy of the 2012 Olympic Games in London, when the organisers were looking at how the athlete’s village would benefit the community rather than property investors. Build to rent is an attractive proposition because it lets developers recoup their costs from recurring long-term rents rather than property sales. Institutional lenders also like build to rent as it provides the certainty of regular returns compared to one-off payments.

All of these changes mean there’s never been a better time for property developers to obtain finance and build in London.

Types of development finance in London

When we talk about property development, we normally use the following terms:

  • Residential property development – this is the development of houses or flats from a brown or greenfield site, or the conversion of a house into flats (or vice versa).
  • Commercial / semi-commercial property development – any type of commercial property, such as offices and shops, or semi-commercial property, such as shops with flats above.
  • Conversions / renovations /
  • Permitted development – where developers can change the use of a commercial building to a residential building without planning permission.
  • New builds or ‘Ground-up’ developments.
  • Single unit to large multi-unit developments.

The types of development finance are:

  • Senior Loans – a first charge loan that would normally make up the majority of the funds needed to complete a property development project.
  • Stretched Senior Loans – a first charge loan that provides a higher Loan to Cost or Loan to Value percentage than a typical Senior Debt facility can allow.
  • Mezzanine Development Finance – designed to act as a top-up loan, to bridge the gap between the developer’s available deposit and the loan available from the senior lender.
  • Equity – the cash sum a developer puts into a project to buy and develop it. Increasingly there are lenders that will help with this part as well.
  • Development Exit Funding – used to repay outstanding finance against a property development once the project is complete.
  • Regulated Development Finance – used to fund the build of property that is to be used as a primary dwelling of the borrower.

Types of development projects taking place in London

  • Light refurbishment – minimal rather than structural changes to the property, such as a new bathroom or kitchen.
  • Heavy refurbishment or renovation – larger-scale changes and upgrades, including new electrics, extensions, loft conversions and converting a property into flats.
  • Permitted development – generally a complete overhaul of existing commercial properties, such as offices that are converted into flats, which don’t require approval from the local planning authority.
  • Ground-up development projects – where development finance is used to finance both the land purchase and the build costs. This is the most comprehensive type of property project and can involve starting with an empty plot of land or require a very extensive conversion or refurbishment when just the shell of the building remains.

 

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How much can I borrow in London?

Costs for projects in London can be more expensive than elsewhere in the UK. When looking at how much you can borrow you will need to factor in:

  • Land costs
  • Build costs
  • Lender fees
  • Professional costs – surveyors, solicitors, advisers, etc
  • Costs for contingencies

A lender will determine the total gross loan they are willing to advance, and then deduct lender professional fees, lender interest, lender arrangement fees and 100% of the build costs first. Any residual loan is then available to draw against the land, so is often referred to as the land loan.

Every lender has different lending criteria, which makes it impossible to know how much they will lend to you on each scheme. If you ask 10 lenders to quote on a project, you will get 10 different answers. That’s 10 different loan amounts and 10 different lots of loan pricing. At the cheaper end of the market, lenders will require a deposit of 30% or more, whereas other lenders will make do with 10% (or less). Understanding how development finance works is often the difference between being a good developer and a very successful developer. Cheap funding can be a false economy, as it means more equity (which normally carries a higher cost). Brickflow’s software does all of the heavy lifting for you, searching the market and giving you real-time access to the development finance market.

How to repay your development finance 

A clear exit plan will have to be established with lenders before they provide a loan. The most common exit routes are:

  • Sale of the finished properties.
  • Long-term refinancing – used when the developer aims to retain use of the completed development.

If you mistime your development finance, then there is always d – this is a type of bridge loan used to clear the original development loan and provide finance until you can sell the site.

Why use development finance to build in London?

There are a range of reasons to use development finance to fund your London property project: 

  • Debt is always cheaper than equity (unless you have access to a lot of your own money). If you put in less capital your returns will actually be higher.
  • You can tackle bigger projects which you would otherwise not be able to afford.
  • You can take on multiple projects at the same time, or start a new development before your existing one has sold or fully sold, increasing your potential profits.