Development finance basics: funding a property project

Development finance funds the construction or significant refurbishment of a property, rather than the purchase of a finished one. It is structured very differently from a standard mortgage, because the lender is funding a project that changes in value, and in risk, as it progresses.

Summary

• Development finance typically funds both the land or property purchase and the build costs, released in stages as work progresses.
• Lenders assess the project against gross development value, the expected end value once complete, not just the current site value.
• Funds are drawn down against completed work stages, usually confirmed by an independent monitoring surveyor.
• A credible exit, sale or refinance onto a term facility, is central to approval, much as with bridging finance.

What development finance actually funds

A development facility usually has two elements: funding towards the purchase of the site or existing property, and funding towards the cost of construction or refurbishment. The two are typically released differently, with the purchase element advanced at completion and the build costs released in stages as the project progresses.

Gross development value and loan sizing

Lenders size a development loan with reference to gross development value, the expected value of the finished scheme once built and sold or let, as well as the total cost of the project, including build costs, professional fees and contingency. Facilities are commonly expressed as a percentage of cost and a percentage of gross development value, with the lower of the two figures often governing the maximum advance. A realistic, well-evidenced appraisal, ideally supported by comparable evidence and a quantity surveyor's cost plan, strengthens an application considerably.

How drawdowns work

Rather than receiving the full facility upfront, funds are released in tranches as agreed stages of work are completed, for example on practical completion of the groundworks, the shell, and first fix. Most lenders appoint an independent monitoring surveyor who inspects progress before authorising each drawdown, which protects the lender but also means delays on site can delay the next release of funds. Build this into your project planning and cashflow from the outset.

The role of the contingency

Because construction projects routinely encounter unexpected costs, lenders generally expect a contingency allowance within the overall cost plan, commonly in the region of 5% to 10% of build costs, and will want to see how it would be used if costs overrun. A project with no contingency at all is a common cause of hesitation at underwriting stage.

Experience and track record

Lenders look closely at the experience of the developer or the project team. A first-time developer is not automatically excluded, but may be asked to bring in an experienced project manager or main contractor, provide a more detailed cost plan, or accept a lower loan-to-cost ratio than an experienced developer with a track record of completed schemes.

Exit strategy

As with bridging finance, the exit matters enormously. Common exits are the sale of the completed units, or refinancing onto a term investment mortgage once the scheme is built and, ideally, let or pre-sold. Lenders will want a realistic view of sales values, informed by recent comparable evidence, and a sensible allowance for a selling period rather than an assumption that units sell the day scaffolding comes down.

Costs to expect

Development finance typically carries an arrangement fee, a monthly interest rate, which may be rolled up and repaid at the end rather than serviced monthly, the monitoring surveyor's fees, usually charged at each drawdown, valuation and legal fees, and sometimes an exit fee. Because of the specialist monitoring and risk involved, overall costs tend to be higher than a standard commercial mortgage, reflecting the higher risk during construction.

Planning and permissions

Lenders will want to see that any necessary planning permission is in place, or close to being secured, before committing funds, along with building regulations approval as the project reaches that stage. A scheme reliant on uncertain planning consent is generally much harder to finance until that uncertainty is resolved.

Preparing an application

Useful material includes the site details and planning status, a detailed cost plan or schedule of works, ideally prepared with a quantity surveyor, comparable evidence supporting the expected sales or rental values, and a clear statement of your own experience or that of your project team.

Getting an indicative view

Development finance is specialist lending, and the right lender depends heavily on the scale and nature of your project. Lending Box can point you towards lenders on our panel suited to your scheme and give an early indication of structure and likely terms. We are a broker, paid by the lender, not a lender ourselves, and all figures are indicative only, subject to full underwriting, valuation and lender approval.