‘definitely something that a lot didn’t expect’ – Surprising Benefits to Development Finance

A: Well firstly, let me explain what development finance is, put simply it’s finance to build new property from the ground up. It’s not for the casual developer as it requires real commitment, however in today’s market it works incredibly well given the UK’s desire to build more quality housing.

To answer the question, I think with development finance, more than any other funding, new clients are surprised that lenders will fund 100% of the build works value, post acquisition. In other words, once the initial deposit (circa 35%) has been paid to acquire land with planning, there are no further significant sums of capital required from the client, subject to the end value.

I also think that many clients are surprised that as the intermediary we encourage a healthy direct relationship between the lender and developer to ensure that it’s a really positive experience, as more than any other type of finance I arrange the borrower and the lender have the most engagement over the term of the loan I would say.

Understandably, it is one of the most risky types of finance from a lender’s perspective, as there are so many facets and it relies on the ability of the borrower to get the project done right and through to completion. Simultaneously from a borrower’s point of view that relationship with the lender is going to be key because it is not like a normal loan, where the loan completes and the money is in their account. That’s it. In that scenario, they probably won’t speak to the lender again for years, if at all.

Whereas with development finance, the money is usually released in stage drawdowns as the development progresses and before each tranche is released the lender will send their QS (quantity surveyor) to make sure the project is to budget, is going as per the schedule of work and is being done to the right standard, but that QS and lender will be incredibly experienced at this type of finance, so you essentially gain a highly experience collaborator to support your project, who can offer advice and supplier suggestions that you might not have been aware of.

It is in the interest of the lender as much as the developer for the project to be a success. Developers, both new and seasoned, seem to really value being able to tap into this experience.
Not forgetting ourselves of course, I like to think I add tremendous value to any client looking to undertake this kind of project, especially where we have so many strings to our bow lender wise for varying projects and client experience. A broker advising on development finance really needs to ensure that beyond the financials they’re recommending, the lender’s approach is going to be a great fit with the developer, and getting that right for my clients is down to pure experience of transacting development deals over the years more than anything.

The positive relationship that I have seen my clients develop with their lender is definitely something that a lot didn’t expect. At the outset, the lender can be seen as just the money provider but often by the end of the project they have built such a trust and relationship with that particular company that clients can gain an unexpected level of confidence in their current project as well as in future ones.

This is why selecting the right lender for a project really is critical at the outset and for each project we’ll always look for the right lender, offering the right terms at the right time.

A: I think the main delay comes from collating the required documentation. As mentioned before, as development finance is seen as more risky for a lender, there is understandably much due diligence before funding is approved to ensure they are lending responsibly. Therefore by providing a schedule of work that is viable and detailed enough is probably one of the easiest ways for developers to avoid unnecessary delays.

Indeed one of the most important pieces of the puzzle is a CV or evidence of prior completed projects. This is great for me as an advisor because it is a tool I can use to drive down the costs. The more experienced the client, the more a lender is likely to reduce margin because of perceived lower risk.

Also, I always say a lender is only ever as quick as the solicitor, so picking a solicitor that has transacted this type of finance before can massively help as they will understand how it works, the need for speed and the true dynamics of the process.

A: This will always depend on the experience of the developer and the size of the project.

We know in the development finance market that a lot of lenders are only generally looking to finance developers with existing experience – this is typically 2-3 prior development projects, and in this space there are many options with many lenders, a handful that we use regularly would be UTB (United Trust Bank), Close Brothers or Lendinvest. This is because both their pricing and service tends to be very strong.

If it was for a first time or second time developer we may be looking toward lenders such as Mint Property Finance.  It’s our job to place as strong a case as possible, illustrating where clients may have transferable skills or have indirect build experience which assist lenders in getting comfortable in lending to clients who haven’t built ‘ground up’ developments before.

I’m very careful where we may use a lender who isn’t often used by us, that we speak to our clients throughout the process to ascertain the level of service that has been offered, it may be that it’s a query case and options are limited, but I feel the feedback loop is important to future clients and it enables us to expand our offerings beyond mainstream lenders who can’t always assist.

I often get excellent feedback from my clients who have used certain lenders, and where feedback isn’t up to scratch we are careful to avoid these lenders where possible without warnings.

One thing as advisors is we are very careful to keep a close eye on lender fees and this very much dictates our recommendations alongside all the other facets of a case. One example is exit fees, and I will always illustrate as much as possible any fees that would normally be payable in my role as the broker, I will make this clear to all my clients.  It’s not to say that we would avoid lenders with an exit fee, but we would look at the overall total costs to ascertain which options are most economical.

Indeed a key point when looking at development finance is what happens if you run past the intended end date, i.e. what are the costs then, these are things that can be overlooked, but a quality advisor will cover these points with you prior to application.

A: At the moment, I would say the biggest barrier is ensuring the cost of work that the borrower proposes marries up with what the lender deems appropriate.

Speaking particularly about ground-up development finance, the way the finance is typically assessed is how much it will cost to build per square foot. So the developer may suggest a reasonable estimate but this might be based on a ‘mate rates’ from a builder’s yard with a discount or from purchasing materials through online providers. The problem this creates is the lender will calculate the cost of the project on the basis of if something goes wrong and they need to appoint a third party contractor to finish the project, so there is a disparity as the lender won’t often be able to secure the same prices.

Another example would be the labour cost estimates may be very different as the client might be doing a lot of the work themselves but the lender may be factoring the cost of appointing a major contractor into their affordability assessments.

I think this is understandable from both sides and obviously no one is hoping that something will go wrong but that is why we see some challenges and the role of the advisor is paramount here.

What I have done in the past is work closely with the client to understand the numbers and to find a happy middle ground with the lender to allow the case to move forward.

Working with the QS themselves can help especially where they understand the situation and know the local suppliers. In certain cases they can be exceptional at finding a middle ground in terms of the lender getting comfortable with a slightly lower cost of works that they would normally accept.

This can stop there being too wide a gap in terms of estimates.  Even though the deal was slightly more expensive, it ensured the client had the best possible chance of getting their particular model of finance approved. This strategy can prove successful where funding is agreed with competitive terms but slightly outside of lenders’ own models.

A: Try and ensure your initial numbers for the project are as accurate as possible. This may sound obvious, and the current market can make projecting costs and valuations a challenge, but being realistic and getting it right at the outset can make or break a project.

If you are looking for a mortgage, for the most part all that needs to add up is the market value and the rent but with development finance build costs have to align, the residual value has to be viable, but the GDV is critical.

If the developer gives a GDV of say £4 million once the work is complete, the whole structuring of the finance will lead back from this figure. With this in mind, the lender will always fully fund the build costs first, then if there is any funding left over in that LTV (loan-to-value) this will go towards the ‘day one’. So if the GDV is calculated wrong, say £3.5 million then this would skew the whole finance and by the point the lender’s valuer has assessed the GDV we’ll be a number of weeks down the line, with valuation and other fees already paid.

A: For me it is the challenge, development finance rates are never ‘off the peg’, so it is down to me to quickly get to grips with the client’s plans, craft a truly bespoke deal that not only fits the developer’s aspirations but aligns with the lender’s often strict criteria and requirements, to present all of the strengths and merits of the case to the lender in a concise and clear manner to help get the finance approved, all while simultaneously driving down the interest rates and flexing the terms to ensure the developer gets the most cost effective solution to fund the project.

I have to look at the bigger picture while also paying close attention to even the smallest of details to ensure there are no hiccups along the way. There are many things that can go wrong and getting it right can take a huge amount of work, expertise and effort. I know it can be daunting to some brokers but for me it is always rewarding when the build is complete and there’s something exciting about knowing you supported that developer to add another successfully completed project to their portfolio and provide a shiny new home for someone to enjoy for years to come. I know I have said it before but Development Finance really is like no other.

Thanks for all that insight Tom.

If you are considering your development finance options, you can chat with Tom or any of our other Bridging specialists to discuss it further.