Funding is required for two elements: in basic terms, you have got to purchase a property which you intend to convert to a residential use normally.
You, therefore, need to fund the purchase and the development. Together, the purchase and the development are collectively known as ‘the costs’ (along with professional, solicitors and legal fees). What we refer to as ‘the costs’ is the purchase of the property and the development combined, and the costs are financed by a combination of equity investment and development finance. It is no more complicated than that until we make it more so, but that is the essence of funding.
Development Finance
The first piece of good news is that development finance is plentiful in the market at the moment; in fact, Banks are tripping over themselves to lend to the right people.
They are competing with one another for good business and therefore lack of experience is not necessarily a barrier to entry.
‘Bank’ is a broad term these days. It is much broader than the main high street clearing banks you may have heard of like Barclays, Lloyds, HSBC and NatWest. There are a growing number of specialist lenders and challenger banks out there, some of which you might never have heard of, but most of them are specialists in their field or sector.
Generally, they will lend anywhere between 65% and 80% loan to cost, sometimes even 90%. If you have a relative lack of experience at this stage, you are likely to be nearer the 65% mark, which means your equity requirement as a percentage of the whole is going to be higher. This is another reason why you might want to start small.
Loan to Cost (LTC)
As mentioned, together, the main costs are the purchase of the building and the development cost, the banks will gear their lending against the overall cost of the deal. The 80-90% loan-to-cost (LTC) finance offers will open up once you have done a few deals, obviously based on track record.
Clearly, if you have done a few deals and haven’t performed well, that might not open up the 80% loan-to-cost offer, it will also affect the interest rates they will charge you.
Let’s work an example through…
Let’s say we are going to purchase a building for £500k and are going to develop it at a cost of £750k. Overall, therefore, the costs involved in this project are £1.25m.
Let’s say you are offered 75% loan to cost on £1.25m – that’s £937,500 in development finance.
Once you have an agreement with the lender to lend you up to £937,500, you will usually start drawing it down against development costs on a monthly basis. The costs get validated either by a QS, a surveyor, or a project manager, who in so doing, confirms to the lender that that portion of the costs has been expended appropriately, and that funds can be released accordingly, safe in the knowledge that that portion of the works has been completed.
This process will be repeated until the development is finished. They simply release the money as the work is done and as you need to pay the builder.
Given that the development finance covers £937,500k against £1.25m costs, that leaves you with an equity investment required for £312,500.
Metrics for Funding
The property development finance companies have metrics which they will consistently use. We have talked about loan-to-costs (LTC) and that they will have a maximum amount of percentage of LTC that they will lend to you based on your experience along with the quality and location of the deal.
There is a rule of thumb regarding LTC that is quite helpful, although it is only a rule of thumb. Generally, finance companies will lend up to 100% of the development costs and up to 50% of the purchase costs, and that usually comes out at around 75 to 80% LTC overall.
As mentioned, funders will often consider other metrics such as loan to value (LTV) which is more accurately described as loan to GDV (LTGDV), so you might see that as well, but whether they measure it using LTGDV, LTV or LTC, their overall loan to any development is likely to be the same.
Importantly, you will only get access to property development finance when you have planning consent that you are going to implement. Therefore, if you buy your target property before you have got prior approval planning permission, you are very unlikely to secure development funding from an institution. What might happen is that you find a building that has got planning permission already granted, but it may not be a particularly good scheme which doesn’t maximise the opportunity. Or it may even have an existing prior approval, but you consider there to be an option to add more value, maybe by intensifying the scheme.
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