A Guide to Property Development Finance
Thinking of borrowing to develop a property? We’ve got everything you need to know about finance for property development in this Rangewell guide.
From understanding the market outlook to laying out your capital stack and spotting risks in your scheme, this guide covers the full property finance process.
The UK's commercial property market is still very much in flux in the wake of the coronavirus pandemic. However, as the economy recovers, there’s no better time to take advantage of the low prices and high vacancy rates for commercial property, even in well sought-after areas such as in London and the southeast.
As of the end of 2020, the UK commercial real estate marketing is worth over 1.5 trillion USD, down 2.42 billion since 2019. However, even with this decline, the UK still boasts the second-largest commercial real estate market in Europe.
We saw real estate investment volumes slow down in the second quarter of 2020 because of the pandemic, making 2020 the year with the lowest investment volumes since 2012. It may seem like we are far from 2015’s real estate investment volumes peak of £72.6 billion. But that’s not to say growth isn’t right around the corner: UK real estate investment is forecasted to pick up in 2021 and reach 51 billion British pounds.
While all sectors suffered during the pandemic, the office real estate industry experienced a drastic decline in take up as the UK government imposed three lockdowns on the country, giving organisations the command to allow people to “work from home if they can.” As a result of this, many offices that were previously filled with staff ended up completely empty - with landlords left to pay the bills and lose out on tenant income.
However, this dark period for commercial property is nearing the end. In the latter part of 2020, and the start of 2021, office take-up reached close to 658,000 square feet in the South East market and 536,000 square feet in the London West End market as of the second quarter of 2021. Even outside of London, businesses are moving back to offices and even investing in new quarters, particularly in the cities of Manchester, Birmingham, and Edinburgh.
To understand how fast the market is returning, property developers and investors pay close attention to yield, which is calculated as the ratio of the rent income and the property value. Of course, there are many factors that impact yields. Increased demand could raise property values causing lower yields while drop in demand and shift in market behaviour could result in the opposite effect..
Keeping the above in mind, as of April 2021, the prime yields of commercial real estate in the United Kingdom (UK) were the lowest in the London West End office market and the industrial multi-lets market, at 3.5 percent respectively. In contrast, shopping centres and leisure parks yields stood at 7.5 per cent.
Even before the pandemic, we were seeing significant shifts in property investment and residential property development behaviour. For example, the rise of ‘alternative lenders’ has proven challenging for the ‘Big 4’ banks (Barclays, Lloyds, HSBC and NatWest). One key difference is that the ‘Big 4’ have become significantly more cautious about who they lend to, and they mainly give loans to existing customers or, in the case of new ones, experienced developers. As a result, investors who don’t meet the banks’ strict criteria are turning to finance brokers like Rangewell, which can provide access to the whole of market, including many specialist lenders in their space.
Property development finance challenges
Alternative lenders bring with them new opportunities for the property development market. From more flexibility to quicker turnaround times and a wider range of finance products, these new lenders are proving fruitful for many property developers who have struggled to meet the demands of the Big 4 in the past. However, even with opportunities like these, come new challenges for property developers looking to finance a project.
Visibility and credibility
Firstly, many developers lack awareness of the market choice, particularly when it comes to the alternative and specialist lenders. Their first instinct may be to apply to the Big 4, but without a pre-existing relationship or a history of projects of a similar nature, they will find it difficult to gain finance at all or borrow under good terms.
For new developers, a lack of brand awareness brings similar challenges, as many lenders are keen to only work with developers with a proven track record. Lacking credibility is one of the biggest reasons why developers fail to get the finance they need. Equally, developers may be hesitant to work with new lenders as it is not always clear whether they will survive the next economic downturn or continue to support a project during turbulent times.
We’ve seen it all before. During the 2008 economic crisis, even the biggest of lenders struggled and some even collapsed, leaving developers in trouble without the backing they need to complete their projects. Even though the recession is still in our recent memory, we continually see new lenders emerging and taking on too much risk. Another recession could result in price drops that these lenders would struggle to re-emerge from. So, as a developer, it’s important that you assess each lender in the same way that they are examining you. If a lender’s terms seem too good to be true, then they probably are.
Finding the right lender
With the above in mind, choosing your lender might seem like a daunting task. From finding a lender who will lend to you through to choosing a provider that will withstand any unforeseen economic circumstances, it’s not something we recommend taking on alone. At Rangewell, we’ve helped thousands of businesses like yours to secure suitable finance from a vast range of lenders, including the Big 4 and specialist lenders in your industry. There’s no easier way to secure property development finance, so get in touch with the team today to start your application.
Getting started in property development
You may have dreams of transforming properties and making a profit at the same time, but starting out in property development is no mean feat. In fact, development is the riskiest of all types of property loans. So, despite the potential for significant returns, there’s a lot to consider before venturing into property development for the first time.
Of course, lenders prefer developers with experience, particularly those who have a proven track record of turning around projects within deadline and budget. But what if you don’t have that? Well, that’s where you have to think strategically about how to present the best case to the lender. At Rangewell, we work with both new and experienced developers to secure funding for their projects, so we know what lenders are looking for and how best to answer their questions.
From compiling comprehensive applications to determining what matters to lenders, let’s look at how beginner property developers can secure the best financing for their residential or commercial projects.
Skills and experience
Property developers require a wide range of skills to guarantee a successful project. From financial acumen to project management and human resources, it’s critical to keep control of every aspect of your development so as to ensure it all goes to plan. However, many property developers bring with them expertise in one specialist area, such as building, joinery or plumbing, and they choose to collaborate with other experts in the field. As a newbie property developer, it’s worth determining your strengths and weaknesses and identifying areas in which you may need outside support. You can’t do it all yourself, so start off on the right foot and use your strengths to your advantage.
When it comes to experience, lenders tend to prefer a minimum of three relevant schemes before they consider you to be "experienced." However, not all projects need to be of equal scale or budget to your forthcoming ones, and any experience is key to gaining the trust of your development finance lender. Even if you have finished development projects in your own home or that of neighbours/family members, this may work in your favour. A successful side extension or loft conversion might not be on par with a full development project, but it’s still relevant in the eyes of many lenders.
In the same vein, if you have a buy-to-let mortgage on another property, or have carried out a heavy refurbishment of another property, this is all worth including in your application - even if your project is not directly aligned with the ones you've worked on in the past.
No two projects are the same, that’s why it’s important to have the Rangewell team on your side to help identify transferable skills and experience that may sway your lender. We’ve helped to secure funding for many commercial and residential development projects, so we know what lenders are most concerned about. This is particularly true when it comes to any environmental considerations, such as flood risks and abandoned mining infrastructure that may impact the success of your project. Equally, if you are developing a listed building or in a conservation area, there will be more hoops to jump through before you can break ground.
Worked on projects under a different name or as part of a larger company? While development finance lenders do prefer experience under the applicant’s name, that’s not to say any experience isn’t relevant. For example, if you have project managed a residential property development for a large company, and you’re not venturing out on your own, then this project is worth including in your application.
As we’ve already mentioned, you can’t do it all. The right team could be the difference between failure and success for your residential or commercial development project, so choose collaborators carefully. If you pick the right partners, this can significantly aid your finance application, particularly if you are an inexperienced developer. For example, appointing a project manager with a proven track record of delivering projects such as yours under budget and within the timeframe will help your lenders to build trust in your plans.
Once you have identified your areas of weakness, consider people you have already worked with as collaborators. These may be friends and family, or partners from past jobs. Along with making a stronger case for your lender, the right collaboration can be a highly profitable venture for any budding developer. While two minds are better than one, remember that the application process will require you to provide any stakeholder's CV and credit score.
There are more benefits to collaboration than just the work, however. Lenders prefer a partnership whereby stakeholders are incentivised, as it provides the motivational boost that partners may need to ensure the project is complete in time.
Whatever your experience, Rangewell can help you secure the funding you need to deliver a successful property development project.
Property finance essentials
Whether you’re a first-time developer or just need to brush up on your knowledge, this section covers everything you need to know before starting your project.
The capital structure, also known as capital stack, is the structure of your property development finance. As a property developer, you will want oversight of your capital structure so you can make the best financial decisions and maximise your investment. While no two projects are the same, most developments have the same layers of capital structure: equity, mezzanine debt and senior debt.
This is the money you or your stakeholders invest in the scheme, be it your savings or profit from another project. Common equity holders tend to get a percentage stake in the project as well as a percentage from the profits. In some cases, common equity holders will receive ongoing payments from the scheme’s profits over a period of time. There is typically no cap on the potential earnings of a common equity holder unless stated otherwise. Lenders want to see partners invest in equity as it shows their commitment to delivering the project.
This is any subordinated debt or preferred equity instrument that represents a claim on a company’s assets - this is surpassed only by common shares.
This holds seniority over all positions in the capital structure. A senior debt lender is paid before any other investor is given a return on their investment. For example, a mortgage lender would be a senior debt investor in the case of the redevelopment of a property. Senior debt holders are in the most secure position as they have the power to take over ownership of the property via foreclosure action if the owner is unable to pay the mortgage. Typically, the senior debt comprises 75% of the total project cost.
Calculating property development finance
Once you understand the capital structure, you are able to begin calculating how much you are able to invest and how much you need to invest to deliver a successful project. With so many different layers, this can be very complex to calculate - that’s why we highly recommend working with Rangewell to apply for finance for your scheme.
While lenders work in different ways, a typical loan is calculated as follows:
- You provide the GDV (Gross Development Value) and the lender provides the lower percentage of this figure, plus a portion of the total development and construction costs.
- Then, the lender will dictate a minimum deposit or amount of equity required, so they can gain trust and ensure you are committed to the project.
- A typical loan comprises a land loan and build loan, the latter of which takes priority in the eye of the lender (hence why an accurate GDV is important).
- Once the build loan is allocated, the residual finance is the land loan, which you can borrow against the value of the land, as long as it respects the day one LTV cap and the lender’s minimum client equity.
In some cases, you will need to consider sweat equity. This is the non-monetary benefit that you or your stakeholders have put into a project, such as labour and time. Sweat equity is the shares given in exchange for these contributions.
A personal guarantee is your legal promise as a business owner to accept responsibility for repaying the loan. This transcends the business as a legal entity so, if your business is unable to repay the debt then you will be financially liable.
A personal guarantee is common in the world of property development finance and many lenders will require them of all stakeholders, not just the project owner. The industry average personal guarantee value is 15-25%, however the higher LTGTV, the more you will be liable for. Banks typically require an even higher commitment, typically asking for twice the cover on a personal guarantee amount.
When you work with Rangewell, we will make sure your application is fully comprehensive and includes everything lenders need to know. For example, you need to submit an Asset & Liability (A%L) schedule, so the lender can identify areas of equity to cover the personal guarantee amount.
While a personal guarantee cannot be a charge over other properties, it can include liquid assets and other assets, although lenders do prefer property assets. Think carefully before putting your home up against the personal guarantee as, in the event of a failed project, they may come for this asset. The Rangewell's experienced team will examine your portfolio as a whole and help you to determine where the best opportunity is for a personal guarantee that will ensure you and the lender are on the same page.
We can also help you to reduce the personal guarantee amount, and create a structure that further protects it in the worst-case scenario. For example, we will ensure you have a contingency built into your loan, so you can reapproach the lender if the project overruns or goes over budget. It’s also worth considering a cash deposit if you are in the position to do so, as this can cover all or part of your personal guarantee.
Remember: your personal guarantee is more of a last resort than actual security for the lender. In the unlikely event that you are unable to repay a loan, the lender will first allow you to use your contingency plan which is built into your finance product. Then, you may be able to approach the lender for more finance. In the case of rejection for further finance, you will be encouraged to sell off liquid assets to recoup the losses. Only failing all of the above will the lender turn to the personal guarantee to repay their investment.
Making the most of your equity
Once you’ve nailed your capital stack, made the most of sweat equity and secured your personal guarantee, it’s time to look closer at your investment. How can you make the most of your equity? While you may not have a significant cash deposit or a full roster of investors to support your ever-growing plans, there are still some measures you can take to make sure your equity goes further.
Consider a deferred land payment
If you are developing from scratch, then you may be able to ask the lender for a deferred land payment, which means you repay a portion of the land loan after the properties have been built and sold. Not all lenders will allow for a deferred land payment, but it can be a helpful cushion if your initial investment is low.
Explore continuation property development finance
In the worst-case scenario, you may find yourself running out of cash. This is where you might turn to continuation property development finance, a specialised form of finance that supports projects already in the thick of it.
Allow for the planning process
If you purchase a development without planning permission, you will supplement the value of the development with sweat equity throughout the planning process. Lenders know that the planning process can be long and complex, so they will often take this into consideration when determining your finance and repayment timeline. Sweat equity will likely give you a leg-up in the eyes of the lender.
Look at second charges
A second charge requires you to use another property as security. So, if this is not your first development project or you are comfortable using your home as a second charge, you will be able to harness the equity in those properties to protect the cash flow.
Use a finance advisor
The most important and beneficial way to make your equity go further is to use a finance broker like Rangewell. Whether you are building from the ground up or buying a property at auction to redevelop, you need an experienced broker on your side to help you find the best property finance options for you.
From the start of your application through to the repayment of your loan, we’re by your side ensuring that you are in the best possible position. A property development scheme can be very profitable, but there are also lots of things that could go wrong, so we help to identify risks early and support you to provide reassurance to lenders so you can get the best rates.
Property finance risks and considerations
Even experienced property developers can fall victim to the pitfalls of property finance. It’s worth reading the common risks encountered around development finance, so you can make smarter decisions and avoid common mistakes.
Lack of research
You might have a lender in mind, a big bank you trust or a recommendation from a friend, but even if you are fixated on this provider in your head, it’s critical that you shop the market. The more quotes you receive, the better you will understand how you are perceived by lenders. Not only may you identify better deals, but you might also spot holes or red flags in your application that are stopping lenders from offering you the best deals.
Research is key, but remember if you work with Rangewell, we’ll do all that for you and provide a suite of comprehensive quotes for you to consider.
As we alluded to above, the application is critical when it comes to a lender deciding whether to lend to you, and how much they are willing to pay. A strong application is particularly important if you are a relatively new property developer and you lack the back catalogue of successful projects that a traditional lender is looking for. We can help you identify benefits that you may not have considered, putting you in a better position with the lender and getting you a better rate. It’s all about knowing what they want and understanding how to best present yourself.
Working with the wrong people
While we did advocate for encouraging stakeholders to invest in the project, that’s not to say you should give equity (or even your time) to just anybody. The wrong contractor could be the difference between delivering a scheme on time or missing the deadline completely. And, if your investors have a poor record of meeting budgets or exceeding deadlines, this may impact your application. Going into business with someone may seem like a good idea over a drink, but it’s not always the right option for everyone
One way to protect yourself in the event of working with others is to ensure they are aware of the personal guarantee from the outset. If they are willing to commit to a personal guarantee, it will put them in a stronger position with both you and in the eyes of the lender.
How to apply for property finance
Now you know about the market outlook, the capital structure and risks to look out for, it’s time to start the application process. Whether you need a refurbishment loan, bridging loan, land loan or a full property development loan, we're here to help.
When you work with Rangewell, we will make sure your application ticks all the boxes. To get you started, here is a list of the documentation you will need to apply for property development finance:
Your development CV
This will give the lender insight into your skills, experience and credit score, even if this is the first project you have led. Past experience working on similar projects will help the lender to see you have a background in this area.
Details of planning permission
If you have already sought planning permission, you should include it as part of your application. If you are yet to start the process, or you are in the middle of it, then include the application in its current state and outline plans for its approval and disapproval. In the same vein, it’s worth mentioning any planning restrictions, such as Grade II listing or conversation areas, at this stage.
Development costs breakdown
How much are you investing and what is the projected GTV? These may only be headline figures for now, but anything will help the lender to determine whether it’s a project they can support.
Schedule of works
A breakdown of your timeline, including a grace period for reselling or letting out the property if required, is vital for any property finance application.
Who are the key stakeholders? The lenders will want to know the background of the team and details of any personal guarantees from the outset.
Your proposed exit strategy
How will the lender get their money back? Now is the time to determine whether you will sell or let your finished property.
Want to learn more about the application process and Rangewell? Read this case study all about how we helped a landlord to secure a £250,000 property development loan for a student housing project in Southampton.
Property finance with Rangewell
Whether you intend to ‘flip’ a property or plan a ground-up development, choose Rangewell as your broker partner. With vast experience helping developers to secure finance for their projects, we’re best-placed to support you in your development goals. We know the common pitfalls and can identify risks before they become costly, so you can deliver a fully comprehensive application to a wide range of lenders, giving you the best chance of securing finance for your scheme.
Often a property development project can yield much potential, but there are significant risks and that’s why many developers struggle to secure finance with favourable rates. We have secured loans for projects like yours, and in specialist fields, so we can tap into the whole of market and find the lender best suited to finance your project.
Want to better understand your property development finance options and start your application? Get in touch with Rangewell today to start the process to secure your loan for property development.