Property development finance: Definition, options and approach for first-time developers

Property development finance is a form of debt-based finance investors and developers use to fund construction projects. It gives them access to the capital they need to buy land and existing property plus pay for building and renovation costs.

Read on to find out:

• The key terms and concepts you need to know if you want to take property finance to fund an investment opportunity.
  
• The three types of property-based loans available for new investors and how you repay them.
  
• Three ways first-time developers can strengthen their funding application.

Property development finance: the terms you need to know

To increase the chances of a development finance lender or broker approving your application for funding, you need to build credibility and trust with them. They need to feel that their money is safe and they’ll get it back in full with interest.

Later in this article, we share how you can strengthen your application, but first, you need to understand how development loans work and the terminology lenders use:

Gross Development Value

This is how much your property or land will be worth when the project is complete, not its current value.

Loan to GDV (LTGDV)

Closely linked to GDV is LTGDV. LTGDV is the percentage of the GDV you can borrow. Very few lenders are willing to lend above about 60-70% LTGDV on development projects.

So, if the GDV of your project is £500,000, you may be able to secure funding for between £300,000 and £350,000.

New property developers should expect a maximum of around 60%. This means, to start your project, you’ll need £200,000 from somewhere else, like your own reserves or a joint venture partner.

Loan to value (LTV)

Loan to value (LTV) is the percentage of a property’s current value a lender will advance. It’s not what it will be worth after any work you carry out.

Loan to cost (LTC)

Loan to cost (LTC) is the percentage of a project’s eligible costs a lender will fund. This includes the build costs and, in many cases but not all, the land/building purchase. Some also lend against contingency budgets and related fees, but check with each lender. 

Staged drawdowns

Most lenders release development loans in tranches, not all at once. You only pay interest on the funds that have been advanced to you, not the whole amount. That’s similar to how credit card companies charge interest on your balance and not your limit.

Before they release the next tranches, most lenders send out an independent monitoring surveyor to check that the work so far matches the plans, budget and quality standards.

Rolled-up interest and retained interest

There are two types of interest on property investment and development loans: rolled-up and retained.

The type of interest affects how much money you receive upfront. Here’s how they work, using, as an example, a £1m loan on 1.25% interest per month over 12 months:

• Rolled-up interest: You get the full £1m minus fees at the start. The interest you owe builds up during the loan and the lender adds it to your final balance so you pay back around £1.15m in total. If you need access to as much cash as possible, rolled-up is better.
  
• Retained interest: Your lender works out in advance how much interest you’re likely to owe over the term of the loan. Instead of advancing you that money, they retain it. So, instead of transferring £1m over to you, you receive £850,000. Retained is better if you want more certainty over cost.

There are also two ways lenders calculate interest: simple and compounded. If lenders charge simple interest, they only charge interest on the loan amount. 

If they charge compounded interest, then you pay interest on the interest you’re charged. To put it simply, each month’s interest is added to the loan, and the next month you pay interest on that bigger balance.

3 property development finance options open to new developers

New property developers have a much narrower range of finance solutions available to them than experienced developers. There are two reasons for this.

First, property development projects are complex. They’re prone to cost and time overruns which new developers have no track record of dealing with. Second, lenders risk losing a lot of money if your project doesn’t work out.

There are, however, many specialist lenders and some mainstream lenders are happy to work with new developers. The three main finance options you may have open to you are:

1. Bridging loan

Bridging loans are short-term, property-backed loans. You can use the facilities to fund property purchases at auction. You can even use them to buy unmortgageable properties because they’re in a poor condition. Some lenders and brokers will be able to process your application and release funds to you within days.

You need security for a bridging loan. That’s usually the property or land you buy with the funds. The lender will almost certainly want to value any asset you offer as security.

As a new developer, you might be able to achieve an LTV of up to 75%. That means on a property you buy for £200,000, you could borrow £150,000 but you’ll need £50,000 of your own money. 

If you need financing to pay for renovation works, basic bridging loans aren’t suitable. Instead, go for a refurb bridge loan or development finance – more on those below.

The term of a standard bridge loan is 12 months although some lenders offer up to 24 months.

2. Light/heavy refurb bridge loan

A light or heavy refurbishment bridge loan is a short-term, property-backed loan you can use to buy and renovate property. Light refurbishment bridge loans are for minor updates and repairs. Heavy refurbishment bridge loans are for properties that need substantial improvement.

Here are the types of work you can use each type of loan for:

As with standard bridging loans, you need to offer your lender security, which can also be the property you’re buying.

In addition to borrowing up to 65% of the value of your property, you may also borrow 100% of the funding for the work that needs carrying out. Lenders pay you the build funds in staged drawdowns (when an inspector has verified you’ve met an agreed milestone). You only pay interest on funds drawn, not the approved limit.

Loan terms are generally between 12 and 24 months.

3. Development finance

Development finance funds the whole project, not just a refurb. You can use it to buy the site and, subject to lender tests, fund up to 100% of build costs. Developers use them to fund new build developments, change of use work, conversions and more.

The amount lenders will lend you varies but typical figures are up to 70% LTGDV and up to 90% LTC. Let’s go through a worked example to see how these limits work in the real world. In this example, the lender calculates LTC on land/property and build costs.

Let’s say you want to buy land for £400,000 and build new residential flats for £600,000. Your surveyor or architect forecasts a property value (GDV) of £1.5m after you’ve completed all the work.

This gives us two figures:

• 70% LTGDV of £1.5m is £1.05m (70% of the expected value)
  
• 90% LTC is £900,000 (90% of the land and build costs)

Your lender will advance you the lower figure of £900,000. You have to put in £100,000 of your own or investor’s money for the land. The lender will release the remaining £600,000 in tranches.

There are other charges you need to factor in on top like valuation fees, arrangement fees, broker fees, stamp duty, exit fees and professional fees. You should also have a contingency in case costs overrun.

If you’re developing an HMO, there are other costs you’ll need to factor in. They include HMO licensing fees, Building Control/RBCA inspection fees and life-safety systems. Add features like a fire alarm to BS 5839-6 and any emergency lighting to BS 5266, including commissioning and maintenance, to your build and upkeep costs.

It sounds complicated but once you understand the rules, it’s much easier to plan and budget on later projects.

How do you repay property development finance?

You repay development funding in a completely different way to standard business loans. In nearly all cases, you make no monthly repayments at all. Instead, with both commercial and housing development finance, you pay your lender in full at the end of the loan.

The reason finance companies take this approach is because they’re keen to protect your cash flow. Projects often overrun in time and money causing pressure on your working capital. If they collect payments from you before you complete the work, you risk running out of funds to finish the build.

To demonstrate how you’ll repay the loan, lenders need to see a solid exit strategy. The three standard exit strategies are to:

• Sell the property: Use the funds to pay off the loan.
  
• Rent out the property: Rent space and arrange a buy-to-let mortgage.
  
• Take out a mortgage: Take out a mortgage on residential property if you want to live there. Do the same with commercial property if you want your business to trade from there.

What if you can’t repay your property development loan?

Sometimes, borrowers discover that they won’t be able to settle their development finance loans at the end of term.

There may have been delays in your project because it took time for planning permission to come through. Or a depressed property market means you can’t achieve the sale or rent prices you want.

If this happens to you, speak to the development finance team at your lender to ask for an extension. If they won’t help, consider development exit finance to replace the facility and give you more time to sell or secure a term mortgage.

How can you strengthen your application for property development funding?

There are three proven ways to strengthen your application when obtaining finance for property development. These approaches give lenders much greater confidence that you can complete the project on time.

Make sure you cover all these areas:

• A credible plan: Provide lenders with a detailed development appraisal and budget showing all the costs involved, a contingency fund and your expected return. If you have planning permission and a Schedule of Works in place, that demonstrates you’re ready to start and are serious about reducing risk.
  
• A clear exit strategy: Lenders may not see the money they advance you again for another 12 to 24 months. Prove you have a realistic plan to repay them, whether through the sale or arranging a mortgage.
  
• A strong professional team: Show that you’re working with an experienced architect, builder and project manager. They’ll plug the gaps in experience lenders worry about if you’re new to development.

While there is no guarantee as a new property developer this approach will work, presenting a strong case can be the difference between an offer and a rejection.

HMO Architects: supporting developers, new and experienced

Property development is a proven way to build long-term wealth and healthy passive income. For new investors unfamiliar with the development process and with no experience in securing finance, most lenders will be cautious about backing you.

Rest assured, however, that with two or three successful projects completed, lenders will feel more confident about you and open up more funding options.

For your first project, make sure you build the strongest possible team around you. HMO Architects has assisted 750 investors and developers bring their projects to life. 

• Borough Road, Liverpool (18 units): We repurposed an abandoned corner-plot office into 18 studio flats and maisonettes, steering the brief from a planned 24-bed HMO to a more financeable flats scheme. The value of the building went from £60,000 to £1.05m with monthly rent at £9,000.
• Grasmere Avenue, London (8 units): We converted a three-bed home into a high-spec sui generis HMO, adding dormer/hip-to-gable and ground-floor extensions to unlock income. The value of the property nearly trebled from £800,000 to £2.2m. Rent increased from £2,500pcm to £11,200..
• Guildford Road, Lightwater (10 units): We re-imagined a mixed-use corner plot (restaurant and tattoo studio) as a large HMO, iterating designs with the council until a way forward was agreed on what was a complex project. The value of the property increased from £750,000 to £1.8m with rent more than doubling from £6,000pcm to £14,000. 

HMO Architects offers these services to investors, developers and landlords:

• Investment strategy calls: Ryan Windsor was 17 when he began building his own extensive property portfolio. He’s helped over 2,200 clients across his career. Book a strategy call with Ryan and get bespoke advice on how to increase your net value and income with HMO properties. Ask Ryan about his BRRR method and how to use it as your investment strategy.
  
• Feasibility call: Before you invest any time or money, speak to one of our specialist teams. Get a breakdown on whether your plan stacks up financially and whether it’s worth pursuing from Giovanni Patania, the Architect Director, and his team.
  
• Planning permission experts: We have experience in gaining planning permission for our clients across 200 councils.
  
• Interior design and exterior planning: Our architects balance investment-led design with tenant appeal to maximise your yield and minimise void periods.
  
• On-site management: Appoint us as your Building Regulations Principal Designer (where required) to keep your project on track and compliant.
  
• Investor-architects: One of our founders is a prolific property investor and his influence and experience ensures every design decision on your project makes financial sense.
  
• A network of professionals: Access professionals in multiple sectors like quantity surveyors and specialist building contractors. We can also put you in touch with a trusted broker who sources the right funding option for your new project.

View our range of development finance case studies to see how we’ve helped clients turn their ideas into sound investments. Read customer stories on HMO, flat, holiday let and housing projects.

Call our experienced team on 01223 776 997 or email us.

Frequently asked questions

Is it possible to get 100% development financing?

If the security you’re offering is the property or land you’re buying, 100% funding will almost certainly not be available, even for experienced investors and developers. Some lenders and brokers will consider offering 100% funding for a build project if borrowers offer additional security, like another property you already own or land with no existing debt.

How much money to start property development?

If you want funding for property development projects, you’ll need to put up to 40% as a new developer. For experienced property developers, that may be a little as 10%.

How to get money for property development?

To access property development funding, either apply directly to a lender or through a broker. The way development finance works means you’ll need a convincing plan, tight budget and exit strategy to gain approval. Most first-time developers use a broker because they know which lenders’ credit committees are open to new applicants.

How do I find investors for property development projects?

Funding property development through investors often means finding either a joint venture partner or a private equity investor to provide financial backing.

How is loan to value (LTV) different from LTGDV?

LTV is based on today’s property value, while LTGDV is based on the expected value after the project is complete. Lenders use LTV for shorter-term loans like bridging, and LTGDV for full development finance.

What are the advantages of using a property development finance broker?

Using a broker can make obtaining finance for property development projects easier. Some brokers offer a development finance calculator on their website so you can check potential loan sizes, interest rates and repayment options before you apply.

Is development funding only for residential property?

Development funding is available for almost all property including residential units, mixed-use projects and commercial property.