A Comprehensive Guide to Development Finance

Development finance is a specialized loan or financing product used to fund the construction, conversion, or renovation of real estate properties. It is an essential tool for property developers looking to finance a wide range of projects, from ground-up developments to refurbishment projects. This type of finance is typically short-term, with funds released in stages as the project progresses.

However, securing development finance is not always straightforward, especially when the borrower has adverse credit or is a first-time developer. Lenders may have specific requirements, including the gross development value (GDV) of the site, the time required for development, and the exit strategy. This guide will explore the ins and outs of development finance, including the different types of development projects, the role of drawdown and day-one advances, and how to navigate the challenges posed by adverse credit and first-time developers.

What is Development Finance?

Development finance is a broad category of loans used to finance property development projects. Unlike traditional mortgages, development finance is designed to cover the costs associated with the construction, renovation, or conversion of properties. It is commonly used for projects such as:

• Ground-up developments (starting from an empty plot of land)
• Refurbishment (renovating or converting existing properties into new units)
• Change of use (transforming a commercial building into residential units)
• Conversions (changing the use of a building, like converting a house into multiple flats)

Development finance typically includes interest-only loans, meaning the borrower only repays interest during the construction phase, with the capital being repaid at the end of the project. The loan is usually provided in drawdown stages as the development progresses.

Key Features of Development Finance

1. Gross Development Value (GDV):
   • One of the most important factors in securing development finance is the Gross Development Value (GDV) of the site. The GDV represents the estimated market value of the completed property or properties once the development is finished. This value will help the lender determine how much they are willing to lend. A higher GDV can lead to better lending terms, as it indicates the potential profitability of the project.
2. Day-One Advance:
   • A Day-One Advance is a portion of the total loan amount that is made available to the borrower at the outset of the project. This is typically used for purchasing the land, paying for initial development costs, or covering planning permission fees. The advance can help the borrower to get started on the project quickly without needing to wait for subsequent drawdowns.
3. Drawdown:
   • Drawdown refers to the incremental release of funds during the construction process. Typically, development finance loans are paid out in stages, depending on the progress of the construction. The borrower will need to submit evidence that certain milestones have been met before the lender will release further funds. This ensures the lender that the project is progressing according to plan.
4. Exit Strategy:
   • The exit strategy is how the developer plans to repay the loan once the development is completed. Common exit strategies include selling the completed property or refinancing the loan into a long-term mortgage once the project is finished. The lender will want a clear exit strategy to ensure that the loan will be repaid in full when the project concludes.
5. Time Required for Development:
   • The time required for development can range from 12 to 24 months depending on the scale and type of project. Development finance lenders will assess how long the development is expected to take and may require a project timeline as part of the application. For large-scale projects, this could extend beyond 24 months.

Types of Development Projects

Development finance is used for different types of projects, each of which may require slightly different lending conditions. Understanding the type of project you’re undertaking is key to understanding your financing options.

1. Ground-Up Development:
   • A ground-up development involves building a property from scratch, typically on a piece of undeveloped land. This type of project is usually the most complex, requiring planning permissions, extensive groundwork, and a long development timeline. Lenders typically offer larger loans for ground-up developments due to the greater costs involved, but they will also require a thorough review of the business plan, the GDV, and the time required to complete the project. The loan-to-value (LTV) ratio for ground-up developments is typically lower due to the higher risk associated with this type of project.
2. Refurbished Development:
   • A refurbished development involves the renovation or refurbishment of an existing property, often to convert it into multiple units or to bring it up to modern standards. The cost and timeline for these projects can vary, but they are typically faster and less expensive than ground-up developments. Lenders may offer more favorable terms for refurbishment projects compared to ground-up developments, as the risks are lower and the potential returns are more predictable. The GDV will often be the deciding factor in how much you can borrow for the refurbishment project.
3. Change of Use / Conversion Projects:
   • Change of use or conversion projects involve transforming an existing building from one use to another, such as converting an old office building into apartments or turning a warehouse into residential flats. These types of projects can often be completed in less time than new builds, but they still require substantial investment. Lenders will want to see a clear plan for the conversion, including detailed feasibility studies and planning approvals.

Challenges of Development Finance for First-Time Developers

For first-time developers, the process of securing development finance can be daunting. Lenders may be hesitant to lend to inexperienced developers due to the inherent risks involved in property development. Some of the specific challenges that first-time developers may face include:

1. Lack of Track Record:
   • A lack of development experience can make it harder to secure finance, as lenders prefer to work with developers who have a history of successful projects. They will want to see evidence that you have the skills and knowledge necessary to complete the development, even if it’s your first project. To overcome this challenge, you may want to consider partnering with a more experienced developer or having a strong team of professionals (architects, project managers, etc.) involved in the project.
2. Adverse Credit:
   • Adverse credit can further complicate securing development finance. Lenders will be cautious if you have a poor credit history, as this could signal to them that you may not meet your financial obligations. However, there are lenders who specialize in working with borrowers with adverse credit, and having a solid business plan and detailed feasibility study can help mitigate this risk.
3. Higher Interest Rates:
   • First-time developers with adverse credit may face higher interest rates than more experienced developers. This is because lenders consider the risk of lending to an inexperienced borrower higher. The rates will depend on the type of development, the size of the loan, and the expected returns, but you should expect higher costs compared to more seasoned developers.
4. Limited Loan-to-Value (LTV) Ratio:
   • Lenders will typically offer lower LTV ratios to first-time developers and borrowers with adverse credit. This means that you will need a larger upfront deposit to secure financing. While LTV ratios can range from 60% to 75% for ground-up developments, first-time developers may face more stringent terms, requiring a larger equity contribution.

Factors That Influence Development Finance

Several factors will influence your ability to secure development finance, regardless of whether you are a first-time developer or an experienced one. These include:

1. Type of Development:
   • The scale, complexity, and risk profile of your development will heavily influence the lender’s decision. Ground-up developments typically carry more risk and require larger loan amounts than refurbishment projects, which may affect the terms of the loan.
2. Gross Development Value (GDV):
   • A higher GDV suggests a higher potential return, which makes the project more attractive to lenders. Lenders will assess the GDV to ensure that it justifies the amount of financing being requested. If the GDV is too low relative to the cost of the project, it may be difficult to secure funding.
3. Exit Strategy:
   • A clear and realistic exit strategy is essential for securing development finance. Lenders want to know how you intend to repay the loan once the project is complete, whether that is through sale, refinancing, or rental income.
4. Timeframe for Development:
   • Lenders will also assess the time required for development. Projects that are expected to take longer (such as ground-up developments) carry more risk, while those with a shorter timeframe (such as refurbishments) are generally more appealing. A 12-month to 18-month development timeline is typical for many projects, but lenders will want to see how realistic this timeline is and whether you have the resources to meet it.

Conclusion

Securing development finance can be complex, especially for first-time developers and those with adverse credit. However, with the right planning, a clear exit strategy, and a solid business plan, it is possible to overcome these challenges. Whether you are undertaking a ground-up development, a refurbishment project, or a conversion, understanding the key elements of development finance — such as GDV, drawdown requirements, and timeframes — is essential to success.

By carefully considering the factors that influence lenders, including the type of development, exit strategy, and loan-to-value ratios, you can position yourself to secure favorable terms and successfully fund your development project.