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5 step guide to How development finance works

Project Financing and Development Loans for Your Next Building Site

By obtaining secured development finance support, you can ensure the starting date for your next property development or building project. With this form of short-term financing, you can begin the first steps toward completing a property conversion. If you have plans for the construction of a large contemporary  apartment complex, development finance can ensure funding. Perhaps you are an experienced builder or a landowner with designs for constructing a new home. Professional development finance is an ideal method of providing secure financial backing for successfully completing your new building project.

What is development finance?

What is development finance? This question is frequently asked by novice builders and commercial design and construction companies in the startup stages. Even if you have worked for a large property development business, you may not be familiar with this type of funding. If you are building a new home for the first time, performing some building finance research can be helpful. By consulting a development finance lender, you can get further information and answers to all of your questions about funding build costs.

Development finance funding provides short-term, secured financing for the conversion, development or extensive renovation of one or several properties. These building project loans are often secured for large, heavy-duty construction. Typically, this type of financing is  more complicated than residential mortgages. Once you are accepted for receiving a development finance loan, initial funding is often issued at the onset of your project. Incremental funding then follows for the duration of the construction and finishing of your building or complex.

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Lenders usually advance funds based on the value of your building site as determined during an inspection. Initial funds issued are normally equal to approximately 60 to 65 percent of the total property value. Once building is started, a member of your lending company or a surveyor-monitor will inspect your site again. For qualifying properties, lenders often advance as much as 100 percent of the total construction costs for your project.

 

If you are building a single home or renovating a home property or small commercial building, a bridging loan (bridge, swing or caveat loan) may meet your needs. Bridging loans provide interim financing for both individuals and businesses. They secure financing for building or renovation projects until larger amounts of funding are obtained. If you currently own residential or commercial property, you can often use it as collateral for gaining loan approval.

Your Five-Step Guide to Understanding How Development Finance Works

Five major steps to gaining a full understanding of how development finance works for commercial and residential property builders are as follows: 

1. Payment of Interest By the Developer or Builder as Borrower

Interest amounts charged on these property development and house builder loans is typically retained by the lender until the construction project completion. At that time, the amount of the loan is paid back by the borrower plus the accrued interest. This prevents the borrower from having to make monthly payments on a loan. Most developers and builders agree that making monthly repayments can be both inconvenient and difficult. This is mainly because cash flow rates can be nearly impossible to predict during the property construction period. Many lenders also prefer to receive a full, one-time repayment of a loan for funding build costs when building is completed.

Since property development finance loans are short-term loans, lenders have no problem with retaining interest charges until project completion. These loans are commonly issued for a time period equaling 6 to 18 months. Simple property renovations may require only three months to finalise. Most lending agents will issue at least 60 percent of the original purchase value of land. They will also lend 100 percent of the development costs and any related fees.

These lenders will retain accrued interest until a project ends provided that the total funding build costs are not greater than 70 percent of the estimated end Gross Development Value (GDV). In general, the maximum term for which you can borrow development finance funds is from 12 to 36 months. End of term is typically property sale or loan refinancing.

2. Primary Finance Costs for UK Property Developers and Builders

Major fees, charges and other borrower costs can vary according to the lender’s requirements. However, the majority of development finance loans require payment of the following primary fees and charges:

 

  • Facility Fee. An arrangement fee (facility fee) is a specified percentage of the total loan cost, gross or net.

 

  • Interest Rate. Payment of development finance loan interest charges may be required on a monthly or annual schedule in some cases. Typical annual interest rates are about 7.0 percent, while monthly interest rates of 1.0 percent are common. Although long-term facilities are higher in cost than short-term, the longer-term have lower interest rates.

 

  • Exit Fee. This fee, also known as the completion fee, is frequently determined as a percentage of the loan’s total (gross or net) cost. In addition, some lenders require the payment of a specific percentage of the finalised project’s total value rather than the amount borrowed.

 

  • Broker Fee. Brokers commonly charge from 1.0 to 1.75 percent of the total house builder loans value. An explanation of this fee and its amount will be included in your initial loan quote. When you engage the services of an independent broker, you can obtain the best deal to meet your needs and align with your budget.

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3. Additional Costs Associated with UK Finance Funding

Other finance costs that are associated with development finance funding in the UK that some borrowers may encounter include the following:

 

  • Valuation Fees. It is frequently essential for an initial valuation to be performed by a third party that is neutral. This is for determining the security’s open market value. The fee usually includes a valuation prediction for the finished project as well.

 

  • Application Fees. An initial application fee is sometimes charged by brokers and lenders. Others may charge fees for providing advice concerning development finance.

 

  • Legal Fees. If a loan applicant must seek legal advice or representation, the applicant must pay all related costs.

 

  • Administration Fees. This term can cover any additional fees that the lender or broker may charge.

 

  • Monitoring Fees. To ensure that an investment is of good quality, development finance lenders must monitor the progress of a building project. They need to determine whether or not this project is attaining its projected goals as planned. Lenders must also ensure that loan funds are being utilised according to agreement terms. These monitoring charges are paid by the borrower.

 

  • Draw Down Fees. When a new funds installment is issued to the borrower, a draw down fee may be charged. The amount of the fee may be preset, or it may vary according to the amount of the installment.

 

  • Telegraphic Transfer Fee (TT Fee). This fee is levied by the banks that are issuing the funds transfers to borrowers. These TT fees are usually minimal and are set at a fixed rate.

4. Overall Cost of Obtaining a Development Loan

There are several factors that determine the rate to be charged for a development finance loan today. First of all, the track record and varied experience of the developer are examined. The development or building project is also evaluated, including the site location for the construction. Then the amount of funding needed for the project’s completion is decided. The loan to value (LTV) is compared to the loan to GDV that is requested.

Large house builder loans of £500,000 or more typically cost from 4.0 to 9.0 percent per annum. Loans of less than £500,000 normally cost between 9.0 and 12 percent per annum. If you have a very strong deal, you may pay only about 6.5 percent per annum. Aside from the interest that you are charged, of course, you may also be required to pay some or all of the additional fees listed in section 3 above.

5. Understanding the Calculation of Your Maximum Funding Amount

There are multiple primary metrics that development finance lenders utilise for calculating the maximum amount of your building loan. These different metrics include the following:

  • Loan to Value (LTV). Lenders use the loan to value ratio for determining the maximum amount of funding for your property development or building advance. Throughout the construction process, a surveyor-monitor will re-evaluate your building site to ensure the validity of this funding limit.
  • Loan to Cost (LTC). The majority of lenders want to ensure that you are putting a specified amount of funds into your building project. This amount is determined with the use of LTC. If your maximum LTC is 90 percent, this means that your lender will put up to 90 percent of your total building cost into your project. You will then need to deposit no less that 10 percent of the total amount needed.
  • Loan to Gross Development Value. The loan to GDV equals the maximum loan percentage that your lending agent will offer. On a scheme costing £1,000,000 with a maximum loan to GDV equaling 70 percent, your ultimate total facility will be equal to £700,000.

By combining these three different metrics, your lender will determine the maximum amount of your property development or building loan. If a conflict among the three different figures results, the lesser of the three amounts will be used for capping your loan. This is the basic explanation of how development finance works.

Development finance is designed for use as a short-term financing method. The facility (lending arrangement) is planned for the duration of your project’s building period only. It includes a grace period to enable you to refinance with a mortgage or other term loan or to repay the loan. You may also choose to change to a development exit option while your building site is being sold. This may be less costly than your development finance loan and can help you to gain greater profits.

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