What Are the Different Finance Types of Property Development?
The property development finance sector can be a minefield if you go it alone. See what types of finance are available and how Rangewell can help.
In the search for property finance options, potential developers must navigate a minefield of options, lenders and packages that vary wildly in their offers and level of support. Some lenders are specialists in your sector who can help with other aspects of your project, whereas others are more general but may have more favourable rates.
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This balancing between capital investment, interest rates, and additional services makes selecting the right type of property developer finance difficult. Here at Rangewell, we act as an independent broker for property developers looking to finance their next project. We will listen to your background and project goals and then present lenders who are most suitable from across the whole of market, ensuring you get in front of the institutions most likely to make your project succeed.
Of course, whether you go through a broker like ourselves or not, you should still seek to understand the different types of property development finance available so you can make a more informed decision.
First-time property development finance
Property finance is an umbrella term that describes all of the various finance options available to anyone involved in the property market. Only ‘property development finance’ is clearer: indicating projects involving some form of construction work.
For first-time property developers, understanding which type of finance you’re going to need relies mainly on understanding what your project is, what level of construction it involves, and your current position in terms of experience and capital.
Some quick guide points are as follows:
- If you’re new to the industry and interested in buying a flat to rent out, choose buy-to-let mortgages.
- If you’re interested in renovating or refurbishing a property, a bridging loan might be ideal.
- If your project involves building from the ground up, you’ll need development finance (some lenders split this between residential/commercial). Typically you’ll only be able to borrow 70-80% of the project’s value, so you’ll need to find the rest yourself.
- Commercial mortgages could cover larger-scale refurbishments or conversions to allow you to buy commercial units like offices etc.
Some projects will require a mixture of funding options. If you’re in doubt about how to budget for your first property development project, take a look at this guide. Talk to a property development finance broker before deciding so you choose the right solution for you.
Residential development finance
This finance option is designed specifically for developers looking to build or extensively renovate a property that will then be occupied under residential use. This can be on a small scale, such as a first-time developer seeking funds to convert a garden outbuilding to a flat, or on a far larger level to cover a property group constructing a new block of flats in a city centre location.
Development finance is its own field due to the intrinsic risk, high costs and lack of tangible asset value associated with the work. Development finance packages typically offer terms around 24-36 months with rolled-up interest. Finance is offered as a calculation of LTGDV (Loan to Gross Development Value), which estimates the final value of the property once construction is finished. Generally, you can borrow around 70% of the property’s estimated final value.
To apply for development finance, the lender will assess the value of the land, cost of construction and estimated final value. They’ll want to understand your capital position and your business plan, so property developers need to have robust information to hand that can hold up to scrutiny and instil trust. Your lender will be assessing your past projects or track record to ascertain your experience and competence to complete the scheme.
If you’re borrowing through your company, lenders will also demand some level of personal guarantee from directors with more than 25% of a stake to ensure they can recoup some of their investment. Many of these finance packages incur arrangement and exit fees, so make sure you understand the lender’s offer before accepting.
Commercial development finance
As you’d expect, commercial development finance is designed to support the cost of developing new commercial property - whether that’s building, converting or upgrading. It is a shorter-term financing option that is secured against the LTGDV of the property. Some lenders will class any development loan issued to a business as commercial, as FCA regulations can’t cover them.
Development Exit Loans
Development finance is riskier to a lender than a mortgage secured against the value of a pre-existing property - so it incurs higher interest rates. Once it is complete, the property is sold and the developer repays the lender and hopefully takes profit from the sale/rental value of the property. But if there are delays in the construction cycle or selling the project is taking a long time, how can you repay the lender?
A development exit loan is a short-term solution for developers who are near completion. If you need to repay your loan before the property is ready to sell, you can get a development exit loan to tide you over while you sell the property or wait for an onward chain.
Development exit loans also provide the opportunity to move onto a less expensive loan in terms of interest. They offer more affordable interest rates because the main ‘risk’ of the project, construction, has been completed - so you can switch your expensive development finance loan and interest rates with a more affordable exit package.
Buy to let
Unlike a loan offered on LTGDV, buy to let mortgages are given as ‘loan to value’ calculations, where a loan is offered based on the current value of the property/security. For landlords with existing property who want to expand or convert, this is a good way to leverage your existing ‘capital’ (the property) as a tool to get beneficial finance rates.
Some landlords opt for buy to let mortgages, especially when the development aspect is limited to light conversion. Buy to let mortgages are similar to high street ones, though interest rates tend to be higher and require a larger deposit. The rental income of the finished property must be able to comfortable repay the mortgage repayments to make the investment worth it.
Some property investors find great projects via auctions. However, the nature of property auctions demands having a means to fund bids and purchases - so some lenders provide specialist ‘auction finance’ where they issue funds far quicker than is possible during the normal process.
Some lenders can even offer auction finance as “agreement in principle” arrangements, where you’ll get finance pre-approved before the auction so you can purchase with prior understanding.
Commercial mortgages can be used to purchase commercial property like offices, shops etc. They work in a similar manner to traditional private mortgages, establishing a repayment plan and interest rate based on the property value over a set time period - usually a number of years.
Existing businesses often take these mortgages out to buy their own premises. Dentists or pharmacists, for example, may want to purchase their own building so they can avoid paying rent. Commercial mortgages can facilitate this by allowing them to raise funds without requiring the large capital investment of outright purchase.
Some private landlords use commercial mortgages to consolidate multiple buy-to-let properties under a single mortgage, creating a single point of contact and minimising arrangement fees.
A bridging loan is a short-term finance product typically secured against property. The loan can be used to purchase the land, the property or work on the property.
Bridging finance is designed to ‘bridge’ a short-term funding gap. Unlike commercial development finance, this is not designed to cover the cost of the entire project, rather a means of improving cash flow during part of the development. Bridging finance is typically repaid quickly, either following the sale of the property or once another finance product kicks on.
Regardless of how organised you are, you never know what’s around the corner. The last two years' events have shown that to be true, so bridging finance is a fantastic, flexible option for those facing the expenses associated with supply chain delays and other common factors that may affect cash flow. A loan of this type can cover anything from one day to 12 months, starting from around £25,000.
Another reason why bridging finance is a great option for those in the middle of development projects is that the finance can be arranged very fast. Due to their very nature, bridging loans allow you to cover necessary costs in the shortest possible time to ensure the continuation of your development scheme. Loans can be released within 72 hours, depending on the circumstances.
If you need short-term finance, reach out to Rangewell’s team of specialist advisors to help you find the right solution for your circumstances and get your project moving forward.
There are specialised forms of bridging finance tailored to suit each project type. So, if you are developing rental properties, then a bridge-to-let loan might be the right option for you.
Like standard bridging finance, this is not designed to cover the full duration of the development project but rather to support the initial property acquisition ahead of replacing it with a longer-term solution once work gets underway.
Again, bridge-to-let takes less time to arrange than other forms of traditional finance. So, you might find this loan helps get a project off the ground while your application for buy-to-let finance is processed and approved.
Continuation property development finance
Like bridging finance, continuation property development finance is designed to help you get through those unforeseen circumstances. Regardless of how comprehensive your business plan is, you may find delays or other external issues causing cash flow issues.
This is a specialised form of finance to support projects that require urgent support. Don’t worry if you aren’t sure what type of finance is right for your circumstances, or whether you will qualify for this or bridging finance. Get in touch with Rangewell’s team of experts, and we’ll assess your circumstances to help provide the best solution to keep your project on the road.
How property finance works
Now we’ve explored some of the most common types of property development finance, it’s time to dive a little deeper into how finance typically works, and where your equity fits in.
The capital stack is the structure of your property development finance, including equity, loans and any other investment. Taking the time to understand your capital stack is vital as it will help you to ensure the smooth sailing of your development and even identify any risks early on. You will be able to make the best financial decisions based on your capital stack.
A typical capital stack has the following layers: equity, mezzanine debt and senior debt.
Common and Preferred Equity
As you will know, equity is the investment that you and your other stakeholders make into the project. This is your stake in the project, and often how lenders are able to assess your involvement. If this is your first project then you may invest your own savings and/or money provided by family members. Experienced developers will typically invest the profit from previous schemes into their next project.
As the name suggests, common equity is the investment that all common shareholders make into the project. Although all projects are different, it’s common that those who invest more will receive their repayment and any promised profits later in the project. Common equity is a risk, so these equity holders might be guaranteed a higher ROI the reward will reflect this - whether that’s a portion of the project or a percentage of the rental income.
Preferred equity gives preference to these equity holders, meaning they are repaid before common equity holders. Therefore, there is a significant benefit to investing at this stage - and this can often act as an incentive to attract new and experienced investors to the project.
Mezzanine debt is any preferred equity or subordinated debt that represents a claim on a company’s assets and this is surpassed only by common shares.
Senior debt holds seniority over all positions in the capital structure, and typically a senior debt lender is repaid before any equity holder or other investor. A common form of senior debt is a mortgage, which gives the lender a very secure position as it is typically held against the value of the property. In most cases, senior debt comprises the majority of the total project cost.
How property development finance is calculated
Depending on the project you qualify for, and which you choose to take forward with your project, there will be different ways of calculating the amount you can lend. Of course, we recommend speaking with our knowledgeable team of experts who have access to the whole of market, including a number of specialist lenders. Not only will they have you find the right finance for your project, but they can also support you with the application process and help you to understand how the process works.
While your advisor will explain how your finance works, here is how a typical loan is calculated:
- The GDV will inform the amount you are able to lend. The lender may calculate their own valuation, depending on the type of finance you require and what stage of the project you are at.
- The lender will offer the lower percentage of the GDV figure, plus a portion of the total costs.
- The lender will dictate a minimum deposit to be provided in equity by you and your other investors. This demonstrates your commitment to the project and gives the lender the reassurance they need to provide the finance in question.
- The loan, which typically comprises a land loan and a build loan, will be issued depending on the approval of your applications.
- Once the build loan has been allocated, the remaining finance is classed as the lang loan, which you will be able to borrow against the value of the land, so long as it respects the day one LTV cap and the lender’s minimum client equity.
Applying for property development finance
Now that you know about the most common types of property finance, it’s time to go through everything you will need for the application process. As we’ve already mentioned, we highly recommend working with an experienced broker like Rangewell to ensure your application is as strong as it can be.
With that in mind, let’s talk about the documentation you will need for your property development finance application:
Your development CV
The lender requires insight into your skills and experience, including any information about projects you have delivered in the past. Even if this is the first property development project you have led, it’s worth including notes about other projects you have worked on. Remember, the lender is assessing the risk of financing your project, and your past experience and the experience of other key stakeholders will inform this process.
Whether you are building from the ground up or transforming an existing space for a different purpose, the lender will require oversight of any planning applications. If you’ve already sought and secured planning permission, this will show the lender your commitment to the project and reduce their risk. You should also mention any planning restrictions, such as conservation areas or Grade listings, as this will also impact the project.
While the application process will dictate how much you can borrow, it’s good to have some figures in mind. You should know the GDV, even if just a ballpark figure. The lender will then be able to determine what percentage of the ultimate value they can lend.
Stakeholders and team
The people involved in your project are very important to your lender. By providing a team bio, you are showing the lender you have thought carefully about who you have trusted to be involved in the project.
Schedule of works
Just like the team bios, the planned schedule is necessary information for any lender as this will inform the terms of the product, and whether you need a bridging loan to get the scheme off the ground.
Your proposed exit strategy
This may seem like a long way away, but it’s vital to provide information about how you intend to finalise the project - whether that’s reselling the property or putting the units on the rental market. Basically, the lender wants to know how they will get their money back.
Property development finance from Rangewell
The right finance can make or break a property development project. Whether you plan to transform a commercial space into smaller units or are building a student accommodation development from the ground up, the type of finance will differ.
To make sure you can access the best possible finance for your project, it’s important to work with the experts. The Rangewell team will work alongside you to assemble your application and identify any risks early on. With access to the whole of market including a number of specialist lenders in the property development space, our team of specialist advisors will help you source the right finance to make sure your project is a success from the outset.
Ready to get started? Contact Rangewell today to meet your advisor and kick off your property development project.