Development finance can be used to fund a variety of activities such as property new builds, conversions, refurbishments and the redevelopment of land. While the initial funding will be based on a business plan and projected valuations, there is a growing need for flexible development finance. This ensures that both the lender and the borrower are able to react quickly to changes in the marketplace and new opportunities.
It is fair to say that the UK development finance market incorporates a wide spectrum of business models. On one side we have traditional UK banks who have adopted a risk-averse approach since the 2008 US sub-prime mortgage market crash. On the other side we have the flexible niche finance companies taking in private banks, challenger banks and peer-to-peer lending platforms. These are companies that tend to take a more accommodating approach to risk and a more creative attitude towards the type of securities used as collateral.
Historically, development finance (often referred to as bridging finance) interest rates were anywhere between 12% and 14%. Competition has had a significant impact on these rates, as well as the low level of UK base rates, with high street development finance now averaging between 4% and 4.5%. Specialist development finance companies tend to operate at between 6% and 6.5% but these are loan packages which are structured to an individual customer’s needs. Comparing high street off-the-shelf packages to niche development finance offerings is akin to comparing apples and pears.
What many people in the UK don’t realise is that the UK development finance market is also central to European funding. The European financial sector has very little (if any) appetite for flexible development finance hence the reason many European investors are looking towards the UK. This not only gives UK operators a growing in depth knowledge of the European property market but also significantly increases their liquidity. This in turn creates an environment in which rates are extremely competitive to the benefit of borrowers.
The enhanced flexibility of the development finance market is central to its recent and expected future growth. The ability to mix and match different elements of finance, look towards short, medium and long-term solutions and use an array of assets as security are fuelling market growth. However, development finance in its most basic form is split into two simple elements:-
The vast majority of development projects will require the initial purchase of a property and then some form of redevelopment. The first element of a development finance agreement will address the cost of the initial purchase. Usually the lender will advance a percentage of the purchase cost with the investor obliged to provide the difference. This ensures that the investor has money at risk which is the greatest means of focusing their long-term attention on success.
It will depend upon the size of the project but lenders tend to release funding stage by stage. For example, the funding for stage II will not be released until stage I has been completed, inspected and signed off. This strategy ensures that the overall financial exposure for both investor and lender are limited in the event of a failed project. The strategy also helps to focus the mind and is particularly effective the more advanced the project – the greater the financial exposure.
As each stage is inspected, and signed off, there may be short-term cash flow obligations which the investor would need to consider, prior to reimbursement.
Even though UK high street banks have reduced their exposure to risk in recent times, they still attract the lion’s share of traditional development finance. However, slowly but surely the likes of private banks, private equity, challenger banks and peer-to-peer lenders are eroding the market share of high street banks. This is a trend which is likely to continue as the ability to negotiate a development finance package which is wrapped around your particular requirements, as opposed to an off-the-shelf deal, can be priceless.
As the development finance market continues its recover we are starting to see an array of different options emerging. It is therefore essential that advice regarding development finance for HNW investors is both accurate and impartial. Rather than inflexible relationships with a small group of development finance companies, we have access to the whole market, including traditional and niche providers. Through our network of contacts we are able to structure your deal from start to finish, advising on issues such as suitable investment vehicles to deal structure, flexible finance options to re-mortgaging opportunities.
While some view development finance as “expensive” it should be viewed relative to the long-term returns it can create. The acquisition and development of a property can significantly increase the end value and offer a whole host of refinancing opportunities. We have also seen the emergence of a new trend with extended financial assistance offered to facilitate a controlled disposal of completed developments. This short-term support, between 12 and 18 months, ensures there is no need for a fire sale of assets and a significant reduction in income if markets turn in the short term. Debt is integral to long-term growth strategies but must be respected and managed appropriately.
We have a wide range of experience and can assist with your journey from initial purchase of property/land through the redevelopment stage and onto the important subject of refinancing. Our advisers are on hand to discuss viability, timescales and rates, 24 hours a day, 7 days a week.