How Do Property Developers Fund Projects?
Whether you are building from the ground up or investing in an ongoing development, it pays to know your property development financing options.
All the information you need
While the economic effects of the coronavirus pandemic are still very much felt across all industries, there is still significant opportunity for property developers looking to start or continue projects.
Consumer behaviour is changing, so property developers would be forgiven for thinking that retail is not a good opportunity for investment. However, with the rise of online shopping and many buyers becoming more aware of the environmental and economic benefits of shopping locally, there is still a significant opportunity for property developers and landlords to win big from retail.
With that in mind, how are property developers securing the funding they need to turn projects into reality in 2022? Changes to the economy and a shift in consumer behaviour across the board mean that financing a large commercial property project is more complex than ever.
Even if you already have a preferred finance provider, it’s always worth working with a knowledgeable broker with experience in your niche who will tap into the whole of market and present the best finance options to you. Securing finance isn’t just about gaining a certain figure to fund a build, the terms and conditions are just as important as the product itself. Without expert guidance and an experienced eye, you may overlook key areas and even put your project at risk with unsuitable funding.
So, whether you are returning to an ongoing development after the pandemic, looking to change the use of a space you already own or considering the acquisition of a brand new property, it pays to know the property development financing options available to you. Keep reading to discover how property developers fund their projects, and what to do to ensure the best finance from the outset.
First, it’s important to have an understanding of the current commercial property marketing and determine how your project fits into the outlook. If your development has been planned for a while, now is the time to revisit the intentions behind your project and ensure it fits in with society’s new way of life.
The commercial property market, while significantly impacted by the pandemic, is expected to recover over the next few years. The UK commercial real estate market, for example, was worth over £1.5tn the USA at the end of 2020, down £2.42bn since 2019. Given the international events that took place during that year, it’s no surprise that the industry (and developers) took a hit. However, the UK still boasts Europe’s second-largest commercial property market, and we expect to see this return to pre-pandemic levels very soon.
It’s understandable that the UK commercial property market experienced such a hit during 2020 as the pandemic hit every part of the business. From imports and exports to staff availability and rental incomes, developers and landlords quickly transitioned from growth to maintenance mode to ensure minimal disruption and loss of profit while the market destabilised.
Now in 2022, experts are forecasting a return to pre-pandemic occupancy levels, significant US investment and a desperate need for upgraded retail and office space over the next decade. There is a particular discussion about the topic of office space in post-pandemic work, as millions of workers adjusted to working from home throughout 2020 and 2021. While most experts agree that flexible working is here to stay, the office space will never be redundant and many companies are simply changing the way they use their premises rather than getting rid of it altogether. This, along with other changes to working behaviours, will see a significant need for property redevelopment and improvements over the next five years.
Like commercial office space, the retail industry was turned on its head over the last two years. With many retailers struggling to make ends meet, we saw the permanent closure of some of the high street’s biggest names, including the acquisition of Topshop to online clothing giant ASOS, and the end of Debenhams 240-year high street reign.
Depending on whether your project is a commercial office space, a retail development or a specialist business space like a dental practice or a care home, then it’s vital to understand the market you are in and how the events of recent years have affected it.
Experience and credibility
Along with your knowledge of the market, your experience and credibility as a property developer will impact the lender’s assessment of your project and, ultimately, the finance you can secure. When determining the finance options available to you, the lender considers several risk factors.
If you are new to property development, have limited experience or have never led a project before, then this will be taken into consideration by the lender and may impact the funding available to you. However, there are still plenty of options available to you. For example, you may choose to partner with a more experienced property developer to gain credibility and tap into their extensive knowledge gained from past projects.
Alternatively, you may accept the finance you are offered with the plan to refinance after a short period once your project becomes profitable, for example you secure office tenants. If you are concerned about how your lack of experience might come across to lenders, then it pays to work with a lender who can help highlight your strengths and identify any risks ahead of time, ensuring you are offered the best possible finance for your circumstances.
Understanding property development finance
Property developers typically fund their projects through a combination of means, including their own investment, finance from lenders and sometimes even investment from friends and family. To get started with understanding your property finance options, let’s look closer at how it works.
Capital stack is the structure of your property development finance. It’s important to understand your capital stack so you can make informed decisions about your property development finance.Your capital stack is also of interest to your lenders as it helps them to determine how they fit into your funding structure, and helps them to identify any risks that may arise
While no two development projects are the same, a capital stack typically has the same layers: equity, mezzanine debt and senior debt.
Common & Preferred Equity
Starting with the basics, equity is the initial investment that you and your stakeholders put into the project. This could be savings, profit from another project or a combination of the two.
Common equity is the equity that all common shareholders have in the project. Typically, the common equity is those with the higher investment risk as they are typically repaid last. To negate the risk of investing in common equity, these stakeholders will typically receive a high ROI, such as ‘owning’ part of your project and benefiting from appreciation in value.
Preferred equity puts investors in a priority position to receive repayment. This is similar to preferred shares in the stock market. As a property developer, you can attract investors with preferred equity. However, it is typically more expensive than senior debt and there are significant risks as it is exposed to the value of the property. In addition, preferred equity holders receive higher interest but don’t usually have a profit share.
This is any subordinated debt or preferred equity instrument representing a claim on a company’s assets - this is surpassed only by common shares.
As the name suggests, senior debt holds seniority over the capital structure. This means a senior debt lender is paid before any other investor. For example, when buying a house, a mortgage lender is the senior debt investor.
Typically, the senior debt covers around 75% of the total project cost and the senior debt holder is in the most secure position of the stack as they often have a contractual right to the ownership of the property should the owner default on payments.
Calculating property development finance
Now you understand how property development finance is typically structured, it’s time to explore how lenders calculate the funding you are offered. The best way to truly determine how much you are able to invest, and what finance you may qualify for, is to speak with Rangewell’s team of specialist finance advisors. With access to the whole of market, including specialist property development lenders across a multitude of niches, the Rangewell team will help you to assemble a comprehensive application, identify risks early on and secure the best funding for your circumstances.
So, your finance advisor will give you a clearer picture about how the finance process will work for you, here’s an overview of how a typical loan is calculated:
- A valuation is carried out to determine the GDV (Gross Development Value) and the lender provides the lower percentage of this figure, usually with a portion of the total costs.
- The lender sets a minimum deposit, or amount of equity required by stakeholders, and this acts as security on the scheme
- Typically, the loan comprises a land loan and a business loan, the latter takes priority in the eye of the lender unless stated otherwise.
- Following the allocation of the build loan, the residual finance is the land loan. You can borrow this against the value of the land as long as it meets the day one LTV cap and the lender’s minimum client equity.
As you can see, even the simplest of projects can be complicated and relies heavily on all parties having a strong understanding of the process and what is required of them. Don’t muddle through it alone, get in touch with Rangewell today to meet your advisor who will be with you every step of the way.
While not relevant to every project, sweat equity can be very beneficial to developers. Sweat equity is the non-monetary benefits that you or fellow stakeholders put into a scheme, and shares are typically given in exchange for these contributions.
One of the most common types of sweat equity is when you acquire a site and secure planning permission, you add value to the land even without laying a brick. Basically, sweat equity puts a price against your time and effort.
As the business owner, you make a personal guarantee to accept responsibility for repaying the loan. When it comes to, this surpasses just the limited company - if you fail to repay the debt, you and your stakeholders may be financially liable.
For this reason, it’s important to understand personal guarantees, how and when you make them and what they mean for the scheme and you as an individual. Typically, the lender will ask for 15-25% as a personal guarantee, however the higher loan-to-value, the more you will be liable for. As always with finance, the lenders assess risks and make decisions based on these, so the higher the risk, the more assurance they will ask for from you.
If your application lacks information or fails to identify the full impact of your scheme, the lender may determine you are unprepared and, therefore, a greater risk to them. When you work with Rangewell, we don’t just provide a list of finance quotes - we help you to gather the information you need to assemble a fully comprehensive application that will provide lenders with the necessary assurance they need to offer you the best possible finance for your circumstances.
While a personal guarantee cannot be a charge over other properties, they can include liquid assets and other assets, although lenders do prefer the security of property assets. That’s not to say you should put your home up as a personal guarantee, although many people do consider this. Remember, if the project fails or you are unable to repay the debt, the lender will come for your personal guarantee, so think carefully about using your home or another family asset for this purpose.
In some instances, we may even be able to help reduce the personal guarantee amount. Our team will recommend a contingency into your loan, so if the project overruns, goes over budget or there are extenuating circumstances like flood damage, you can return to the lender and ask for an extension.
Personal guarantees can be daunting for even the most experienced developer, as they do impact you as an individual and you cannot protect yourself with an LTD company. However, if your finance is calculated accurately and you are regularly working with your broker to ensure the project is within your budget and any risks are identified early, then the chances of the lender coming for your personal guarantee are very low. As long as you have a good contingency plan and open communication, you should be able to renegotiate with the lender to refinance.
We’ve discussed the structure of your finance, and how equity is a part of that, but how do you make your equity go further? Here are some factors to consider that may help you to maximise your equity.
Deferred land payments
While not relevant to all developers, a deferred land payment might be of interest if you are purchasing land for your project. A lender may provide a deferred land payment which will allow you to repay a portion of the land loan after the scheme becomes profitable, whether that’s sale or rental. This isn’t available to all developers, so it's worth asking your advisor at Rangewell if it could work for you.
Continuation property development finance
You may never need this, but it’s worth knowing about it just in case. Continuation property finance is a specialised type of finance that helps to cover ongoing projects struggling with cash flow issues brought on by a myriad of common issues like delayed deadlines or material shortages.
A second charge allows you to use another property as security. As a developer, you may have other completed projects or be comfortable using your home against a second charge, which will allow you to tap into equity in those properties and improve cash flow for the current project.
Work with a finance advisor
We can’t stress enough the importance of working with an experienced advisor who can work with you from start to finish. From identifying risks, compiling evidence, assembling the application and sorting through available finance packages, your advisor will help you to not only secure finance but also save money in the long run.
Finance application process
Ready to apply for property development finance? When you work with Rangewell, you will receive the necessary support to assemble an application that will help to put you in the best stead for success. To get started with your finance application, you’ll need the following documentation:
Your property development CV
This will cover the experience you have as a property developer, either leading or being part of past projects. Don’t worry if this is the first project you are overseeing, previous experience working on similar projects will show the lender that you have experience in that area.
You will need to identify the amount of equity you and your stakeholders intend to invest, and the projected GDV of the scheme. A lender may want their own surveyor to carry out an independent valuation, so just headline figures will do at this early stage so your lender can see that you have an understanding of investment, finance and the resulting profit.
Planning permission and any land restrictions
If you have already secured planning permission or are in the process of seeking it, then you will need to include this information in your application. Equally, if you have acquired a property with restrictions, such as a listed building or on a conservation area, then you will also need to inform the lender of this at the earliest opportunity.
Planned schedule of works
Of course, you might not know the detailed schedule of works at this stage, but if you have determined an idea completion date and identified where key stages fall between now and then, then be sure to include this in your application
Stakeholder and team information
Your stakeholders may choose to be involved in the finance process, or they may defer any decision making to you. For example, if you have received investment from family members, they may just require a formal agreement detailing what they get in return and won’t need any other information.
In addition, if you have already appointed a senior team to lead the project, such as a project manager, construction lead and electrical engineer, then the names of these people and the nature of their agreements should be included in the application.
Your proposed exit strategy
What happens upon completion of the project? Are you developing homes to be sold or a commercial development to be rented to other businesses? This is vital information for the lender as it may impact the terms and length of contract they are able to provide for you
Want to learn more about the application process? Take a look at this case study about how we helped a landlord to secure a £250,000 property development loan for a student housing project in Southampton.
Property development finance with Rangewell
Understanding how property finance works is just the first step towards working on your own project. Now you know how property developers fund projects, and the most common property finance options and considerations, you are well-prepared to start your first scheme.
Even if you have already led on similar projects or have property finance with other lenders, then you will still benefit from working with Rangewell’s team of specialist advisors to tap into the whole of market and access the best finance to help transform your planned project into a reality.
Want to talk about a project or find out more about property finance? Get in touch with Rangewell today.