How To Fund Your Property Development

An essential part of any development is finding the right finance. If you can show a track record of successful developments, more options become available, so experience counts. Beyond that, it depends on how much you need to borrow and the type of development.

What are your development funding options?

Most developments use a mix of equity and debt. Two worked examples show how this can work. The figures are illustrative only, and the interest rates are guide rates from 2021. They are not a forecast or an offer.

• Example 1: nine apartments
• Example 2: six houses

The key questions are where the funding comes from, how it is structured and what it costs.

Example 1: nine units

Scenario: a block of 9 apartments with planning permission

• Net sales revenue (GDV): 100%
• Land (including acquisition costs): 32.5% of GDV
• Build costs: 35% of GDV
• Other costs: 11% of GDV
• Total costs: 78.5% of GDV
• Developer’s margin: 21.5% on GDV, 27.4% on cost

Funding:

• Developer’s equity: 2% of costs
• Equity partners: 18% of costs
• Senior loan: 80% of costs
• Total funding: 100% of costs

Comments:

• The developer puts in only a small amount of equity.
• Equity partners are needed to fill the gap between the developer’s equity and the loan.
• Senior debt is lower risk, typically up to around 60% loan to GDV. Here, instead of a mezzanine top-up, a stretched senior loan was used, taking lending up to around 70% of GDV (or 90% of costs), at a higher interest rate on the whole loan.

Example 2: six units

Scenario: a development of 6 houses with planning permission

• Net sales revenue (GDV): 100%
• Land (including acquisition costs): 33.7% of GDV
• Build costs: 34.7% of GDV
• Other costs: 11.2% of GDV
• Total costs: 79.6% of GDV
• Developer’s margin: 20.4% on GDV, 25.6% on cost

Funding:

• Developer’s equity: 10% of costs
• Senior loan: 75% of costs
• Mezzanine loan: 15% of costs
• Total funding: 100% of costs

Comments:

• The developer provides all the equity, a larger share than in example 1.
• The senior loan is around 60% of GDV. Rather than a stretched senior loan, the developer has topped up with mezzanine finance.
• Mezzanine sits behind senior debt and can take total lending to around 70–75% of GDV. Because it is riskier for the lender, it is considerably more expensive than senior debt.

Stretched senior versus mezzanine

Cost is the most important consideration, so compare the interest rates of each option.

Rates are not the only cost. There are legal fees and valuations too. Each lender will have legal costs, and sometimes each requires its own valuation, adding cost.

A stretched senior loan means dealing with only one lender. With senior plus mezzanine, both lenders must agree terms, which can delay the start of a project.

Joint venture funding

A joint venture (JV) is a common option for larger developments, often a partnership between a developer, a builder and a funder. Typically the funder pays most or all of the costs of buying the land and building the scheme, charges interest, and a profit share is agreed for the final profit.

The developer’s capital at risk is reduced, but they must keep the scheme on budget and on time, and the profit share is often linked to this. For example, a developer might receive 65% of the profit if a build finishes in 15 months, falling to 50% if it slips to 18 months.

Funders typically look for a healthy margin on GDV and on cost, and for the right team to deliver. If you are stepping up from 3–6 units to 12, you will need to show relevant experience. JVs can be especially useful when you are doing a new type of development, as the partner brings contacts and experience of similar schemes.

When should you talk to lenders?

As early as possible. Early conversations give you headline terms, confirmed later once you have a site and detailed information. Lenders will typically ask for:

• A track record of delivering projects of a similar type and size
• Asset and liability statements for the main shareholders and directors
• Credit history, with any past issues declared and explained
• A description of the development and a full appraisal
• A set of plans
• Planning status, including Section 106 or CIL
• Evidence that the proposed GDV is achievable

Development finance in practice

Be realistic. Your predicted return is not guaranteed, so check your assumptions, back them up with research and plan the build with your main contractor, so that you only borrow what the development really needs.

Two things to remember:

1. An experienced building contractor on board strengthens your funding case.
2. Good finance brokers and lenders will help you find the most cost-effective structure.

Funding varies from project to project, and you will often combine several options. Get the match right and the project starts on a solid footing.