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 themself.