Development finance is the funding used to build, convert or substantially refurbish property. It is different from a mortgage in almost every respect: the money is released in stages rather than all at once, the assessment is about a project rather than an existing income, and the loan is repaid by selling or refinancing the finished scheme.
If you are planning a development for the first time, or have only ever used a mortgage, this guide explains how it works.
What development finance funds
A development facility typically covers two things:
- The site or building. A contribution towards the purchase of the land, or the existing building to be converted. If you already own the site, this element may not be needed, and the site can instead form part of your equity.
- The build costs. The cost of the works, including construction, professional fees and often a contingency.
Lenders usually express what they will fund as a proportion of total costs and, separately, as a proportion of the end value. Both limits apply, and the actual figures vary between lenders and projects. The difference between what the lender funds and the total cost is the equity you need to contribute.
How lenders assess a development
Because there is no rent or trading income yet, lenders assess the project as a whole. The main things they look at are:
- The site and planning. Where it is, what permission exists and what conditions attach to it. Most lenders want planning in place before they fund the build.
- The scheme. What is being built, how many units, of what type, and for what market.
- Costs. A detailed build cost estimate, usually with a contingency, plus professional fees, finance costs and other costs to complete.
- End value. The gross development value, or GDV, is what the finished units are expected to be worth, supported by evidence of comparable sales or lettings.
- The developer. Your experience of similar projects, and the experience of your contractor, architect, project manager and other professionals.
- The exit. How the loan will be repaid: sale of the units, refinance onto a term facility for units you intend to keep, or a combination.
- Equity. How much of the total cost you are contributing, and in what form.
Every lender has a different appetite for project size, location, type and developer experience. This is a specialist area, and most developments are placed through brokers who know which lenders suit which schemes.
How the money is released
This is the part that differs most from a mortgage.
- Initial advance. On completion of the facility, the lender releases funds towards the site purchase, or towards works if you already own the site.
- Staged drawdowns. As work progresses, you request further funds. The lender usually appoints a monitoring surveyor who visits the site, confirms the value of work completed and reports back. Funds are then released against that certified work, typically in arrears.
- Practical completion. The final drawdown follows completion of the works and the surveyor's sign-off.
Because funds are released in arrears, cash flow needs careful planning. Contractors expect to be paid, and there can be a gap between incurring a cost and drawing against it. Experienced developers build this into their appraisal.
Interest and fees
Interest on development finance is normally rolled up, added to the loan rather than paid monthly, because the project generates no income until the end. Lenders also commonly charge an arrangement fee and an exit fee, and there are valuation, monitoring and legal costs. All of these vary between lenders and should be included in your appraisal so that the finance cost is part of the total cost of the scheme.
Repaying the loan
Development facilities are typically for the length of the build plus a period to sell or refinance. The loan is repaid as units are sold, with the lender usually taking an agreed share of each sale, or by refinancing onto an investment mortgage for units you keep and let. Delays in sales are a common source of pressure, so many developers plan an exit strategy that does not depend entirely on selling everything quickly.
Common mistakes
- Underestimating costs. Build costs, professional fees, finance costs and a realistic contingency all need to be in the appraisal.
- Optimistic end values. Lenders will commission their own valuation; if it comes in below your figure, the funding changes.
- Ignoring cash flow. Drawdowns in arrears mean you need working capital.
- Leaving finance too late. Arranging development finance takes time; start before you exchange on the site.
Where FundingFrame fits
FundingFrame does not assess viability, value schemes or lend. Our checker asks the questions a development specialist would ask first: the site, the planning position, what you intend to build, approximate costs and end value, your experience and your exit, and structures the answers into a Deal Snapshot. Where appropriate, we introduce it to a specialist commercial finance broker who can discuss the options with you.
Key points
- Development finance funds the site and the build, with funding expressed as proportions of cost and end value.
- Lenders assess the project as a whole: planning, scheme, costs, GDV, developer experience, exit and equity.
- Money is released in stages, usually in arrears, against work certified by a monitoring surveyor.
- Interest is typically rolled up; fees and monitoring costs should be in the appraisal.
- The loan is repaid by selling or refinancing the finished units.
- Realistic costs, cautious end values and early planning of the finance avoid the most common problems.