Development finance in the UK provides various funding solutions specifically designed to support property development projects. This type of finance is crucial for property developers, construction companies, and real estate investors who need to finance the building or substantial refurbishment of residential, commercial, or mixed-use properties. The loan is typically disbursed in tranches, with funds released at key stages of the development project.
Key features of development finance
Purpose
Development finance funds large-scale construction or major renovation projects. This includes building new properties or significantly altering existing ones, whether residential, commercial, or mixed-use. It’s used when standard mortgages aren’t suitable due to the project's scale or complexity.
Term Length
These loans are short-term, typically ranging from 6 to 36 months, designed to cover the construction period. Developers aim to complete the project, sell, or refinance before the term ends, making precise planning crucial.
Funding Structure
Funds are released in stages (known as drawdowns) as the project progresses. For example, initial funds may cover land purchase, with further releases tied to construction milestones. Each phase is usually reviewed by a professional to ensure progress.
Interest Rates
Due to the higher risk of property development, interest rates are higher than traditional mortgages. Rates vary depending on the lender, project, and developer’s experience, reflecting the unpredictability of construction timelines and costs.
Loan-to-Cost (LTC) and Loan-to-GDV (LTGDV)
LTC refers to the percentage of total project costs a lender will finance (typically 70-80%). LTGDV is the percentage of the project’s final value they’ll fund (around 60-70%). Both ratios show how much of the project cost comes from the developer's funds.
Exit Strategy
A clear exit strategy is essential. This often involves selling the property to repay the loan or refinancing with a long-term mortgage. Lenders expect a well-planned exit to ensure the loan will be repaid once the project is finished.
Common Uses of Development Finance
Residential Developments
Used to fund the construction of new housing projects like apartment complexes or housing estates. It covers costs such as land purchase, construction, and labour, helping developers meet housing demand by creating new living spaces.
Commercial Developments
Finances the construction of commercial properties, including office buildings, retail spaces, or industrial units. Developers use it to build spaces for businesses to operate, lease, or sell.
Mixed-Use Developments
Supports projects that combine residential, commercial, and leisure spaces in one development. These projects create multi-functional areas where people can live, work, and shop, especially in urban settings.
Refurbishment Projects
Covers major renovations or conversions, such as turning an old building into modern flats or upgrading outdated commercial properties. The finance helps with structural changes, repairs, and modernisation.
Land Acquisition
Provides funds to purchase land with the intention of developing it into residential, commercial, or mixed-use properties. This is often the first step in a larger project, with further development finance needed for construction later on.
Lender Requirements
Detailed Project Plan
Lenders expect a thorough development plan that outlines every aspect of the project. This includes detailed architectural designs, proof of planning permissions, and a clear timeline of when each phase will be completed. Cost estimates should be realistic, covering land acquisition, materials, labour, and other expenses, giving lenders confidence that the project is well thought out and achievable.
Experienced Developer
Lenders prefer to work with developers who have a proven track record in property development. Showing experience on similar projects (whether residential, commercial, or mixed-use) can increase the likelihood of securing finance. Developers without experience may struggle to gain approval unless they partner with an experienced team.
Valuation and Appraisal
A professional valuation is necessary to confirm the value of the land and the potential Gross Development Value (GDV) once the project is completed. Lenders use this to assess the risk and ensure that the property’s future value will support the loan. Accurate appraisals help set the Loan-to-GDV ratio and determine funding.
Deposit/Equity
Most lenders require developers to invest their own funds into the project. This usually means putting down 20-30% of the total project cost. The developer’s own capital acts as a buffer for the lender, reducing their risk and showing the developer’s commitment to the project.
Exit Strategy
A clear plan for repaying the loan is essential. Lenders will expect to see an exit strategy, such as selling the completed property, generating rental income, or refinancing with a long-term mortgage. The exit strategy needs to be realistic and aligned with market conditions.
Creditworthiness
Both the developer’s personal and business credit history are carefully reviewed. Strong creditworthiness demonstrates reliability in repaying previous loans and reduces the risk for the lender. Any major issues in the developer’s financial history can be a red flag for lenders.
Contractor
Lenders may ask for information about the contractors hired for the project. They’ll want to know the contractor’s experience, their track record on similar developments, and the terms of their engagement. This ensures the project will be handled by qualified professionals.
Financial Stability
Proof of financial stability is key. Lenders will typically request business accounts, tax returns, and possibly personal financial statements to ensure the developer is in a solid financial position. This shows that the developer can handle any unforeseen costs or delays during the project.
Types of Development Finance
Senior Debt
The primary loan used to fund the bulk of the project’s costs. It is typically secured against the property being developed. Senior debt usually has lower interest rates compared to other forms of finance but requires the developer to have a solid credit history and a strong exit strategy.
Mezzanine Finance
A secondary loan that sits between senior debt and equity. It can help fill the gap if senior debt and the developer's equity don't cover the entire project cost. This type of finance is riskier for the lender because it’s repaid after the senior debt, so it usually comes with higher interest rates. Mezzanine finance can be a useful tool for developers who need to bridge the gap in funding without giving away more equity.
Equity Finance
Developers may raise capital by offering equity in the project to investors, who then share in the profits. It’s a common option for developers looking to reduce their loan burden or attract partners who bring valuable experience or connections to the project.
Advantages of Development Finance
Tailored Financing
Designed to meet the specific needs of property developers.
Staged Release
Funds are released at key project milestones, ensuring that the money is used effectively.
Supports Growth
Enables developers to take on large-scale projects that would otherwise be financially out of reach.
Disadvantages of Development Finance
Higher Interest Rates
Reflect the higher risk compared to traditional property loans.
Stringent Requirements
Detailed project plans, professional valuations, and proof of financial stability are essential.
Increased Risk
Developers need to have a clear exit strategy to ensure the loan can be repaid.
Final Thoughts
Development finance is a specialist form of funding tailored to the needs of property developers. It provides the necessary capital to undertake significant construction and renovation projects but comes with stringent requirements and higher risks compared to traditional property loans. It’s crucial to have a well-thought-out project plan and a clear exit strategy to secure this type of finance. If you think development finance might be the right solution for you, we recommend you get specialist advice to help you understand the process and find the best option for your needs. At L&C Mortgages, we specialise in a wide range of mortgage products, but we do not advise on development finance. To ensure you receive the best guidance and support for your project, we have partnered with Propp, an expert in specialist property finance. Propp is an award-winning specialist broker with extensive knowledge and experience to help you secure the right funding tailored to your specific needs.
Important Note on Broker Fees
Unlike L&C Mortgages, Propp does charge a fee for its service. For expert advice on commercial loans, we recommend you contact Propp, who will clearly explain their fees and service before you commit to using them.
Specialist mortgage advice is provided by Propp, who are authorised and regulated by the Financial Conduct Authority (914408). Propp is not a part of L&C, nor is L&C a part of Propp.
L&C receives a % of the commission that our partner Propp earns. All applications are subject to lending and eligibility criteria.
Propp is a credit broker, not a lender, that works with the whole of the market.
The FCA does not regulate commercial mortgages.
