In today’s challenging market, it’s more important than ever to be able to secure development funding quickly so you don’t bloat timeframes and rack up more costs.
There’s also a chance that lenders may be more cautious about who they’re giving their money out to, so you’ve got to come prepared and be clear on what you need.
And in order to do so, you need to have a good understanding of the different options that are out there.
Different development funding options
There are lots of different funding options out there and it can be hard to know which will be the best fit for your development.
Below, we break down some of the most common funding types – explaining what exactly they are and when it is best to use them.
Senior debt is a common form of funding for property developers in the UK. It is a type of loan typically provided by banks or other financial institutions, and it is secured against the property or development project that it is being used to fund.
The basic principle behind senior debt is that the lender is given the first claim on the project's assets in the event of default. This means that if the developer is unable to repay the loan, the lender has the right to take possession of the property and sell it to recoup their investment.
Advantages of senior debt:
- Flexibility: Senior debt can be used for a variety of projects from ground up developments to conversions. There is a lot of choice in the market when it comes to criteria, gearing and appetite.
- Lower interest rates: It typically has lower interest rates than other forms of debt, such as mezzanine debt or equity financing. This makes it an attractive option for developers looking to reduce their borrowing costs.
- Cost: Senior debt is typically lent in drawdowns. This means you only get charged interest as you draw the funds.
Considerations with senior debt:
- Risk for the borrower: Typically the lender will require a personal guarantee.
- Cost overruns: Typically the borrower will be responsible for any cost overruns.
- Limited funding: Senior debt typically only covers a portion of the total development costs, which means that developers will need to contribute equity or find an alternative equity source in order to complete their projects.
Private equity firms can provide funding for property developers in exchange for a share of ownership in the property development project.
When the project is completed and sold or leased, the profits are shared between the property developer and the investor based on the terms of the agreement.
You will often need to provide a portion of the money needed for the project as equity on your end, however, there are 100% models that exist, meaning no equity would be needed from the developer.
Advantages of equity funding:
- No interest payments: Unlike traditional loans, equity funding does not require the property developer to make interest payments. This can help to reduce the financial burden of the project.
- Shared risk: With equity funding, the investor shares the risk of the project with the property developer. This can help to reduce the financial risk for the property developer.
- Smaller capital requirement: Because the developer will have to put less of their own cash in it means they can take on more or larger projects.
Considerations with equity funding:
- Shared control: When an investor provides equity funding, they become a partial owner of the project. This means that the property developer may have to share control over the project with the investor.
- Limited funding options: There are limited numbers of equity partners in the market compared to senior debt.
- Coupon and profit share: Some providers will charge a coupon on top of their profit share, which means more of the developers profit could be eroded if there are delays.
Mezzanine finance is typically used to fill the funding gap between the amount of equity that a developer has committed to a project and the amount of senior debt that they are able to secure. In other words, it sits between the developer's own equity and senior debt on the capital structure.
Mezzanine finance is typically provided by specialist lenders who offer a loan that is secured against the property being developed. The loan will typically have a higher interest rate than senior debt, as it represents a greater risk to the lender. However, the lender may also receive equity-like upside, allowing them to benefit from the future success of the project.
Advantages of Mezzanine finance:
- Opens up options: Mezzanine allows developers to take on projects that they may not have been able to due to their equity position.
- More control: Mezzanine finance can be structured in a way that allows developers to retain control of their projects, unlike equity funding which would require them to share ownership.
Considerations with Mezzanine finance:
- Costs could be higher: It can be more expensive than senior debt, as the lender is taking on a greater level of risk.
- Lenders can be pickier: Mezzanine finance can be harder to obtain than senior debt, as specialist lenders are often more selective about the projects they choose to finance.
- Complex to structure: The senior lender will have to allow the mezzanine provider to sit behind their charge.
A bridging loan is a type of short-term finance used to provide funding for property professionals and developers in the UK.
The lender will typically offer a loan amount, interest rate, and loan term. The loan amount will typically be based on the value of the property being used as collateral, and the interest rate will be higher than traditional loans due to the short-term nature of the loan.
The borrower will typically have to repay the loan in full at the end of the loan term, which is usually between 3 and 24 months.
Bridging can be used for a wide variety of reasons, such as renovations, time-sensitive purchases, buying properties which are not mortgageable, or simply raising capital.
Advantages of bridging loans:
- Quick access to finance: Bridging loans are typically approved and funded quickly, making them an ideal option for property developers who need funding fast to secure a property or start a project.
- Flexible repayment terms: Bridging loans offer flexible repayment terms, with the option to repay the loan in full at the end of the loan term or make interest-only payments each month.
- No early repayment fees: Bridging loans usually do not have early repayment fees, which means the borrower can repay the loan early without incurring any additional costs. Typically a 3 month minimum interest requirement is implemented.
Considerations with bridging loans
- High interest rates: Bridging loans typically have higher interest rates than traditional loans.
- Short loan terms: This means the borrower will typically need to repay the loan in a short time frame which can be challenging for property developers who need longer-term funding.
- Risk of default: If the borrower is unable to repay the loan in full at the end of the loan term, bridging default interest can be exceptionally expensive and this can be particularly risky for property developers who are already stretched financially.
How can we help?
No matter which development finance option you choose, at LandFund, we can help you to find the perfect funding match for your project.
We have a wide network of trusted equity partners, banks, and private funders who have a range of exciting solutions and options to suit your funding needs. From equity to bridging, we have a partner who’ll be able to provide what you’re looking for.
Our data-driven brokerage service not only strengthens your application (as we know exactly what our partners are looking for) but it speeds up the process and ensures that you are getting the best rates.
On top of our brokerage service, LandFund also helps you to create lender-ready appraisals in minutes. Simply use one of our templates, or build your own custom reports, to generate accurate appraisals in just a few clicks. Now with build costs data to help you benchmark against other projects in the area.
And if that’s not enough, you can use LandInsight, to source and assess your next opportunity – with seamless integration between the two products.
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