Property development finance is a solution required for property developers to fund the construction of a project, be it for new developments or the conversion and refurbishments of residential or commercial land and property. This type of finance is usually in the form of a short term loan, although there is an increasing number of options available on the market to meet your requirements.
Time is often of the essence when it comes to property development, so in order to create the best possible funding solution for a project, you will need to move fast.
Property development finance usually comes in the form of a short-term loan, which can be broken down into two parts. The first part is designed to help you with the purchase of a site, and in many cases, a lender will advance a percentage of a purchase price and leave you to fund the remaining amount (although lenders vary on this point).
The second part of the loan is to finance the build of the project. Generally speaking, a lender will often advance the total cost for this in stages, as and when they are completed. The lender will then certify the work and funds for each stage so you can pay suppliers. This means you will often need to have sufficient cash flow to fund the initial stages until you are reimbursed.
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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 the 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 is 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 the 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.
While some participants, such as high street banks, have reduced their exposure to UK development finance, others have stepped in to fill the void. There are now more specialist UK development finance companies than ever before and the market is still growing. The UK market is fairly unique because the appetite for development finance in Europe is negligible. This in turn has allowed UK operations to also work with European investors/developers expanding not only their reach but also their experience and understanding of property markets and trends.
Historically the cost of short-term finance was anywhere between 12% and 14%. This was a time when high street banks had a monopoly on all areas of the finance market. This has changed dramatically since 2008 and the US sub-prime mortgage crash which weakened bank balance sheets, leading to reduced risk profiles. While high street banks have not completely removed themselves from the development finance market, they are not as competitive as their specialist counterparts.
The rate for high street development finance is generally between 4% and 4.5% with specialist financiers operating between 6% and 6.5%. The major difference is that specialist finance companies will lend up to 75% of the gross development value as opposed to just 50% for high street banks. The approval timescales are also very different; high street banks can take between six and eight weeks while some specialist development finance companies can have provisional offers in place within 48 hours.
The UK development finance market covers a whole range of different investment opportunities from pre-planning permission developments to large redevelopments and everything in between. Housing developments have recently attracted more than their fair share of interest of late as the UK government continues to push for more affordable homes. There is currently a shortfall of around 300,000 new homes across the UK. This has attracted the attention of private property developers as well as housing associations (now able to borrow larger sums as a consequence of recent legislation changes).
It is fair to say that nobody saw the 2008 US sub-prime mortgage crash coming and the consequences are still being felt today. Many high street banks saw their balance sheets decimated with emergency funding commonplace. The initial step back from UK development finance was understandable although the current lack of appetite is a little surprising. This created a vacuum which has been filled by specialists and private banks across the globe.
One very interesting development revolves around the funding of specialist financial companies by high street banks. In many ways, this gives them the best of both worlds, direct investment in a growing market without a hands-on daily management role. We’ve also seen the introduction of a hybrid short/medium-term funding tool. Offered by specialist finance companies, end of project finance arrangements of between 12 months and 18 months allow developers the chance to organise a phased exit.
Historically, high street banks would have turned away developers looking for this type of extended finance. However, the ability to instigate a more managed exit avoids a short-term drop in prices to address potential cash flow issues. This is one of the reasons why we have not seen a significant fall in property prices (a race to the bottom) despite some concerns about the short term direction of the UK market. In the past, developers often had no option but to exit at literally any price.
It would be unfair to say that high street banks have left the UK development finance market but their appetite has certainly diminished. The new route for high street banks appears to be the direct funding of specialist operations, offering them the best of both worlds. They are still extremely strong in areas such as term loans, buy to let, etc, but rigid deal structures and extended negotiating periods have reduced their competitive edge in development finance.
In many ways, the high street banks come into their own further down the financing chain. Once a development has been completed the next stage is refinancing – enter the high street banks. By entering the process towards its conclusion this reduces their risk profile although it also decreases their potential returns. You could argue this perfectly fits their new risk-averse profile in light of the 2008 US mortgage market collapse.
As we touched on above, specialist lenders filled the vacuum left by high street banks when they reduce their exposure to the UK development finance market. Specialist lenders are able to create bespoke packages structured in a fashion which is both efficient and cost-effective. In many ways, it is dangerous to compare bespoke development finance offers against the one size fits all/off-the-shelf service offered by traditional banks.
Other important factors associated with specialist lenders are an ability to be nimble, quick thinking, open to new and innovative financial structures and able to bring deals together quickly, sometimes within 48 hours. The risk-averse nature of European banks ensures the lion’s share of the business is funnelled back towards the UK market.
Traditionally, bridging finance lenders have been used to bridging funding gaps between property acquisitions, development and the finished article. Once completed a project would simply be refinanced on the enhanced value, raising funds to pay off the bridging debt and often allowing developers to bank a profit. Their role is a little more enhanced in the modern era, providing often complex solutions to an array of traditional and non-traditional scenarios. These can include anything from the acquisition of warehouses to funding requirements for a start-up company. Once established, these entities can then refinance their debt at a significantly reduced rate.
The offering of bridging finance to start-up companies is seen by many as a vital part of the UK economy going forward. Many of these companies have perfectly good business models but risk-averse high street banks prefer them to be more established. So, bridging finance can be a means to an end for many of these companies.
In the past, it was relatively easy to list a number of potential barriers to achieving finance including liquidity, collateral, country of residence, property development experience and type of property involved. Today the situation is very different as specialist finance companies can create a structure which will address the most complex of situations. As a consequence, the main barrier to achieving funding is simply the quality of the deal – do the numbers stack up?
Even though the specialist UK development finance market is fast-moving and ever-changing, there are still basic elements which are important to lenders. However, sometimes it is useful to take a slightly different approach to affordability and work back from possible exit routes. We know that exit routes could be refinanced, outright sale or a phased sale over 12 or 18 months, but is the original deal affordable and returns acceptable?
Some of the more traditional elements which lenders will review include development experience, GDV, collateral and the quality of third-party contractors. There also needs to be an incentive for an investor to succeed, often measured by the amount of personal capital invested. Here at Enness, we have vast experience in specialist finance which means flexibility on the structure and very few hurdles which cannot be overcome.
The London development finance market has historically been extremely buoyant, fast-moving and central to the UK property sector. It is fair to say that the perceived challenges of Brexit have reduced the historic premium on London property. However, actual property prices have held up extremely well, which is not always reflected in sensationalised media headlines. In simple terms, if the numbers stack up in the London property market then development finance will be available.
On the flipside of the coin, we have also seen a change in the attitude of development finance companies to markets outside of London and the South-East. It is fair to say that the regional markets are still catching up on London but many lenders are increasing their focus/exposure with Birmingham, Leeds and Liverpool performing well. The ongoing focus on affordable housing development finance, and changes in regulations allowing housing associations greater access to debt, is positive and likely to continue in the longer term.
The London property market has been written off time and time again only to return stronger than ever. The firm backbone of demand from both domestic and international investors remains, reflected in the way in which property prices have performed of late.
There is no doubt new trends are emerging in the UK development finance sector with specialist groups coming to the fore. Even though the high street banks seem to have lost some of their appetite for risk, they have significantly increased their funding of specialist operators. Despite the doom and gloom headlines surrounding Brexit, the actual impact on London property prices has been much milder than expected. The development finance market is extremely liquid and very deal orientated. If the figures add up, whether in London or in regional markets, there is finance available.
We have access to literally hundreds of lenders across the development finance market, can structure deals to address the most complex financial scenarios and arrange an array of different exit routes. Rumours of pent-up demand towards the end of 2018 would appear well founded with a busy start to 2019.
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