Property Developer Guides

We get it.  Development finance is complex, even for experienced developers.

So, we’ve created the Brickflow Property Developer Guides to help unblur the lines, break through the jargon and explain the process in words you won’t need to google.

If we’ve missed anything or you’d like us to explain more, please contact us.

Calculating Development Finance

 

Background

 

Development finance is the most complex property-based loan to calculate. 10 different lenders will provide 10 different loans.  Only speaking to a few means you’re missing out on the best deals, or you’re investing too much equity. To maximise profit, you need to maximise debt.  Here’s everything you need to know to maximise yours.

 

Need to know

 

As a starter, it’s key to understand the Capital Stack.  This is the structure of your development finance, or the different layers that fund a scheme.  The typical stack has three layers, and normally includes senior debt, mezzanine debt and equity.

Debts are repaid from the bottom up, so the higher up the lender, the bigger the risk they incur.  This also means, the higher up the debt, the more expensive it is, so equity is always at the top of the stack, followed by mezzanine or 2nd charge, with senior lending (1st charge) at the bottom.  Lenders will want visibility of your capital stack to see where they fit in your hierarchy of funding, and to determine potential ROI vs. level of risk.

 

A loan is calculated like this:

The lender lends the lower of a percentage of the GDV and a percentage of the total costs

The lender sets a minimum deposit, or amount of equity required, making sure it doesn’t exceed their internal day one leverage cap

The loan is broken down into two component parts; land loan and build loan

The build loan takes priority and is allocated from the total loan first, so essentially the lender works backwards

The lender covers the finance costs, professional fees, build costs and contingency first

The residual (leftover) loan is the land loan, and is available to borrow against the land value, providing it respects the day one LTV cap and minimum client equity

The difference between the senior land loan and the property purchase price, costs, value and associated costs, is your equity.

 

You also need to think about:

 

Sweat Equity

If you’ve purchased the site already and enhanced the value through planning, this may be considered as part of your equity.  This is called Sweat Equity because you’ve essentially done all the hard work.  Every lender has a different way of calculating sweat equity, some are more generous than others, and some will use 100% of sweat equity, creating a ‘cashless deal’, so again, shop the market.

 

Costs

If you have met ongoing site costs (debt servicing, security, maintenance, etc.) you can legitimately assign them to the project and the lender will take them into account for their calculations, so keep a ledger.

 

In practice:

 

Debt is always cheaper than equity (unless you’re sitting on a big pile of cash).  But due to the lack of transparency in the market, even experienced developers don’t know it because they’re missing out on the best debt deals.  Developers are borrowing from lenders at a low LTGDV and giving away profit share to plug the equity gap.  What feels like a good deal is a false economy because they’re giving away 50% of their profits to secure the investment they need to mobilise the deal.

Like building a development, you need to work from the bottom up to structure your debt.

We created Brickflow to give you the power and knowledge to search the entire market, quickly, finding the best loan for you.  It might be the cheapest, it might be the largest, but it will always be the loan that stretches your equity the furthest.

 

Download as a PDF:

Property Developers Guide PDF

Application Process

 

1 / Provide documentation

You will need to provide the following key elements to apply for your loan:

 

Developer experience

Your skills, professional qualifications and previous development history.  You’ll only have to provide this once and we’ll save your information for any future applications.

 

Development appraisal

An essential tool for developers and lenders to assess the land value of any piece of land, site or building.  You will no doubt have this info ready, which should include all costs (acquisition, build and sales) and expected GDV.

 

Development schedule

A detailed list of your properties/units with square footage and sales prices.

Asset & Liability (A&L) schedule for shareholders and personal guarantees

A list of your personal assets and liabilities, required to demonstrate adequate cover for your personal guarantee(s).  A personal guarantee is your legal promise to repay loans issued to a business where you are a beneficial owner.

 

Anti-money laundering

A valid identity document (passport, driving licence etc.) and proof of address (utility bill, bank statement etc.)

 

Source of wealth

A summary of where you obtained your funds, with relevant supporting documentation.

 

2 / Valuer, QS and Solicitors engaged

Once the lender receives all of the above, they will confirm credit-backed terms and instruct their Quantity Surveyor (QS) and valuer.  You will need to cover these fees upfront or agree to cover the cost even if the loan does not complete.

The valuer will:

Confirm site value and suitability for security

Run a high-level sense check on the build costs

Confirm the GDV of the end units

Provide a report within 10 days

 

The QS will:

Closely examine costs and construction methodology, working with the valuer

Assess you and your ability to deliver the scheme on time and within budget

Agree a drawdown schedule with you

Provide a report within 2-4 weeks

Once the reports have been assessed by the lender, solicitors will be appointed. They can be appointed at the same time as the QS and valuer, but we recommend waiting to avoid incurring unnecessary costs.

 

Solicitors:

You will need to cover the solicitor costs

Most lenders will insist that your solicitor has construction expertise in-house

The solicitors will deal with the construction and loan documentation

The process will take up to 4 weeks

 

3 / Drawdown

The QS will conduct a final visit and inspection to confirm works, and if satisfactory, will confirm drawdown with your lender.

 

Download as a PDF:

Property Developers Guide PDF

Making your equity work harder

 

If you don’t have a hefty deposit to help secure development finance, it doesn’t mean it’s game over for your ambitious development plans. There are many ways to stretch your equity further and source the funds you need. Here are some of them.

 

1 / Cracking your capital stack

 

The Capital Stack is the structure of your development finance, or the different layers that fund a scheme. The typical stack has three layers, and normally includes senior debt, mezzanine debt and equity. Strategically determining the best capital stack for your project allows you to minimise your equity investment and maximise your Return on Capital Employed (ROCE). Read our more detailed guide to the Capital Stack here.

 

2 / Shopping the market (and why cheap debt is mostly a false economy)

 

The default setting for many developers is to stick to a tried and tested senior lender. But deposits vary from 10% to 35% of total costs (including land, build, finance and professional fees), so on a scheme with costs of £5m, the required deposit could be anything from £500K to £1.75m. A huge and potentially deal-breaking variance. If you only have a relationship with one lender who requires a deposit at the higher end of the spectrum, it could mean investing an additional £1.25m of equity, blocking investment for other schemes, and preventing you from progressing to bigger sites, sooner.

Here’s an example of how shopping around for property development finance can stretch your equity further:

A site has combined land and build costs of £6m

GDV is £9m and build term is 12 months

Exit strategy is sale of the units, so with an 18-month loan term there is 6 months to sell the units

Two developers have £1m of equity each

 

Developer X keeps it traditional

Borrows from a high-profile High-Street lender. Rate is good at 5%, but he needs £2.1m in equity (35% of costs)

He invests £1.1m of his own equity and finds £1.1m from an investor on a profit share basis

He agrees to pay the investor 10% interest and 40% of the profit

Lender costs are £500k, taking total costs to £6.5m

Profit is £2.5m, so the investor is due £1m (40%) in profit share and £100k in interest (a fantastic return of 100% for the investor)

Developer X earns a good pre-tax profit of £1.5m in 18 months

 

Developer Y keeps it smart

Searches the entire market and finds a different lender

His rate is higher at 7.5%, but he only has to invest £600k of equity

He doesn’t need an investor and doesn’t need to give 40% of his profits away

The cost of the debt is £800k, so total costs are £6.8m

The profit is £2.2m, but there is no profit share, so he keeps it all

He earns £700k (pre-tax) more than Developer X over the same time period (on this scheme)

He also has £400k of additional equity, so is able to run a second smaller scheme over the same period, which earns him another £1.4m

He earns £3.6m over 18 months (versus Developer X at £1.5m)

The only difference is Developer Y shopped around for his funding

 

3 / Leveraging your network (smartly)

 

The best property developers have the ability to bring in the right partners to make a scheme work. This applies to obtaining finance for property development, and making debt work for you. It’s unlikely that using a single source of funding is the most cost-effective route, so look to your friends, family and wider professional network to help raise equity where you can.

Having said that, if you need to partner with investors to make a scheme happen, don’t be too generous with your profit share. You’re the driving force behind the development and without you it wouldn’t be on the table, so remember this when assessing your funding options.

 

Here’s an example:

 

Developer X keeps it traditional

Borrows £5.5m from a High-Street bank at 5% interest, based on 55% LTGDV on value of £10m

Total costs are £7.5m (pre-finance), leaving £2m of equity to find

He has £1m, so needs to find the rest from an investor

After the finance costs are added, he makes £2m in profit, but has to share half the profits with his investor

He makes £1m profit, which is good, but could be better

 

Developer Y keeps it smart

Shops around and secures a slightly higher rate of 7.5%, but a LTGDV of 65%

Therefore, he needs only £1m equity, which he has, so doesn’t need to find an investor or offer a profit share

He makes £1.75m profit (after finance costs). An extra £750k over the same period as Developer X

 

4 / Considering a second charge

 

Second charge loans mean you can use equity in background portfolio properties as security for another loan, even if you have an existing mortgage, so they’re a great way to conserve cash. They offer flexible funding, and can normally be secured fairly quickly as second charge lenders are setup to work quickly, making them a strong alternative to re-mortgaging or draining your cash.

If you have some BTL properties in the background that are lowly geared, this could be an option. Lenders can even take a second charge over multiple properties to give you an overdraft type facility to use as and when you need to raise a deposit.

 

5 / Leveraging the planning process

 

If you buy or option a site without planning permission, you will add value during the planning process, commonly known as sweat equity. This places value on the time and effort put into a project. Securing planning permission isn’t easy, so good lenders will take this into account when assessing a funding application for a property development loan, and lending opportunity.

Every lender will place a different amount of value on sweat equity, so make sure you search the market to find one that appreciates the value you add as an experienced property developer.

An added benefit of buying during the pre-planning phase comes if you need an investor. You can repay your equity when you raise the development finance for the build stage, meaning you’ll only need to pay your investor a percentage of the profit on the uplift during the planning process, not on the total profits at the end.

Here’s an example:  

  • Developer X buys a property for £1m
  • He takes a net bridging loan at 70% LTV
  • He has £200k in purchase costs and planning costs, so total investment is £1.2m
  • He splits the £500k deposit equally with an investor and they agree a 50/50 profit share
  • 9 months later he secures planning permission, and the site is worth £2m, so there is £800k of ‘profit’
  • He owes the investor £250k (his original investment) plus £400k profit share
  • He is able to raise development finance of £1.35m + 100% of build costs
  • £700k is used to pay the bridging loan back, and the investor is paid £650k (£250k + £400k profit)
  • Developer X is able to fully repay his investor after 9 months, meaning he keeps the £2.2m profit the scheme generates once it has been built, rather than paying his investor 50% (£1.1m)

 

6 / Requesting a deferred land payment

 

When a developer is looking to buy a piece of land, the landowner can agree to receive part of the payment once the properties have been built and sold (usually at a higher price as the trade-off). This is known as a deferred land payment, and it’s worth asking the question if you’re short on

equity. The lender providing the development finance has first charge over the land and lends all of the build costs, plus a portion of the land acquisition costs.

As the buyer, you would be giving the lender security over a site that is worth more than you paid for it (so far). This de-risks the lender and allows you access to greater value projects with smaller deposits, so it’s a full circle win. The landowner will normally request a second charge behind the lender and would have to agree to be repaid only after the lender. Not every vendor will agree to this, so you need a good relationship in place. You could also offer a small profit share to further sweeten the deal (if needed).

Not many developers are aware of this strategy, and not every lender will agree to a deferred land payment. If they do, each lender will take a different approach, so seek expert advice from a broker before choosing your loan for property development.

 

The figures in the worked examples are for illustrative purpose only.

 

 

Download as a PDF:

Property Developers Guide PDF

The Capital Stack

 

Defined

 

The Capital Stack is the structure of your development finance, or the different layers that fund a scheme.  The typical stack has three layers, and normally includes senior debt, mezzanine debt and equity.  Strategically determining the best capital stack for your project allows you to minimise your equity investment and maximise your profits.

 

Need to know

 

Debts are repaid from the bottom up, so the higher up the lender, the bigger the risk they incur and the more expensive the debt

Equity is always at the top of the stack, followed by mezzanine or 2nd charge, with senior lending (1st charge) at the bottom

Lenders will want visibility of your capital stack to see where they fit in your hierarchy of funding

This lets them determine the potential ROI vs. level of risk.

 

In practice

 

Not all lenders require a big deposit, so don’t always default to your trusted lender, and shop the market to keep your equity longer

Deposit requirements range from 10-20%, so for a development with costs of £10m, a deposit could vary by £100k, creating a huge opportunity cost from lost equity if your loan deposit is at the higher end

When a lender requests a large deposit, an obvious route is to secure an investor on a profit share basis, but this can prove a false economy

Experiment with different loan structures to avoid hefty profit share payments. 

Here’s an example:

  • Developer X borrows at 5%, but needs to put down £800k of equity
  • Developer X only has £400k, so secures £400k from an investor
  • 12 months later, the scheme completes and he pays the 5% interest and gives the investor 40% profit
  • On the same project, Developer Y finds an alternative lender and borrows at 7.5%.  The rate is higher, but he can borrow £400K more
  • Developer Y pockets all the profit and still has £400K to invest in his next scheme

Within 18 months, Developer Y uses his retained equity and additional profit to complete on a second scheme

 

 

Download as a PDF:

Property Developers Guide PDF

Personal Guarantees

 

Defined

 

A personal guarantee is your legal promise to repay loans issued to a business where you are a beneficial owner. Providing a personal guarantee means if the business becomes unable to repay a debt, then you accept personal liability, meaning you can’t just walk away.

They are standard practice for development finance and are required from all shareholders, or as a corporate guarantee.  The Industry average is 15%-25% of total loan amount.

Normally, the higher the LTGDV, the higher the personal guarantee.  Banks usually want twice the cover on a personal guarantee amount, so if the amount is £1m, they require evidence of a Net Asset Value (NAV) of more than £2m.

 

Need to know

 

Liability is joint and several, so if two of three shareholders do a runner, you will be responsible for the full amount, not just a third

They are not charges over other properties. You will need to submit an Asset & Liability (A&L) schedule during the application process and the bank will look for sufficient equity value to cover the personal guarantee amount

Personal guarantees include liquid assets and property assets (property is preferred as cash can disappear)

Equity in your main residence can count towards the NAV but the lender may discount this as it’s harder to realise in the event of a claim

The lowest level of personal guarantee is cost overruns, which are normally only allowed for loans with a lower LTGDV

 

In practice

 

Personal guarantees are conceptual security, rather than actual, alternative security. They’re there to ensure both lender and borrower are strategically aligned. Lenders don’t expect to enforce them and they only do as a last resort, but they exist in case things go wrong.

 

Each lender will take a different approach, but here’s how they might work in reality:

 

If you’re unable to repay a loan (normally because a development is over time, budget or property prices are falling), you would first use the contingency built into your loan

After the contingency is spent, you can ask the lender for more funding, but the lender may decline if you are already at the leverage limit

Further shortfalls could be met out of liquid assets, but failing that the bank could look to enforce the personal guarantee (through the courts if necessary)

 

Here’s how you may be able to reduce a personal guarantee amount:

 

Increase your contingency, which is built into your loan.  Industry standard is 5% of build costs, so look to up this

Lower your LTGDV to below 50%, and lenders may make an exception

Offer a cash deposit as an alternative, or supplement part of the personal guarantee with cash

Get your contractor to secure a performance bond

 

 

Download as a PDF:

Property Developers Guide PDF