Deposit requirements on development schemes typically range from 10% - 40% of total costs. On a scheme with £10m of costs, that is a swing of around £3m of your own money, on the same project.
That single number explains why structuring matters more than shaving a few basis points off a headline rate. Drawing on Brickflow's experience structuring these deals day to day, this article covers how a development loan is actually calculated, how the capital stack works, what the total cost of borrowing looks like once fees are included, and the practical levers developers use to stretch equity further.
Development finance is a short-term loan used to fund construction, conversion or refurbishment, repaid on sale or refinance at the end of the project. It is also one of the most complex property-based loans to calculate, so it pays to understand the mechanics.
Key Highlights
- Deposit requirements typically range from 10% - 40% of total costs, so the lender and structure you choose can swing your equity requirement by millions on a large scheme
- The capital stack has three main layers - senior debt, mezzanine, and equity - repaid from the bottom up, meaning the top layers carry more risk and cost more
- Every lender calculates the loan differently: which of GDV or total cost caps the deal, how sweat equity is treated, and how the land/build split is worked out all vary
- Comparing headline interest rates alone is misleading - True Monthly Cost, which factors in arrangement and exit fees, gives a fairer like-for-like comparison
- Several practical levers exist to stretch equity further: shopping the market, bringing in partners, leveraging planning uplift, second charges, and deferred land payment
The Capital Stack
The capital stack is the structure of development finance: the different layers of money funding a scheme. A typical stack has three layers, and equity can be further divided into preferred equity and common equity.
Working example:
|
Layer |
Position |
Typical limits |
|
Senior debt |
1st charge, bottom of the stack |
Normally 60%–65% LTV and/or 80%–90% LTC |
|
Stretched senior |
Sits above standard senior |
Normally 70% LTV and 90% LTC |
|
Mezzanine (2nd charge) |
Above senior |
Normally 75% LTGDV and 90% LTC |
|
Equity |
Top of the stack |
Cash, normally attracting an interest rate of around 10% plus a profit share, for example 40% |
Two quick definitions if they are new to you. LTGDV is the loan as a percentage of gross development value, the estimated finished value of the scheme. LTC is the loan as a percentage of total project costs.
What You Need to Know About the Stack
- Debts are repaid from the bottom up, so the higher up the stack a lender sits, the greater the risk they carry and the more expensive that money is
- Equity is always at the top, followed by mezzanine or second charge, with senior lending at the bottom
- Lenders want visibility of the whole capital stack so they can see where they sit in the funding hierarchy
- That visibility is how they judge potential return against level of risk
Getting the stack right means minimising equity investment and maximising profit. Like a building, structure the debt from the bottom up.
How a Development Loan is Calculated
Every lender does this slightly differently, but the mechanics follow a consistent pattern:
- 1. The lender lends the lower of a percentage of GDV and a percentage of total costs. Both caps are tested, and the smaller number wins.
- 2. The lender sets a minimum deposit, or amount of borrower equity required, making sure it does not exceed their internal day-one leverage cap.
- 3. The loan is split into two parts: a land loan and a build loan.
- 4. The build loan takes priority and is allocated from the total loan first, so the lender is effectively working backwards.
- 5. The lender covers finance costs, professional fees, build costs and contingency first.
- 6. The residual, or leftover, loan is the land loan, available to borrow against the land value, provided it respects the day-one LTV cap and minimum client equity rules.
This is why two lenders can look at identical numbers and produce very different day one advances. If the same project goes to ten lenders, you will get ten different loan amounts along with ten different sets of interest rates and fees.
Sweat Equity
If a site has already been purchased and enhanced in value through planning, that uplift may count as part of developer equity. It is called sweat equity because the hard work of adding value has already been done.
Every lender calculates sweat equity differently. Some are far more generous than others, and some can use 100% of it, creating what is effectively a cashless deal. Again, this is a reason to shop the market rather than assume.
Previous Costs
If a developer has been meeting ongoing site costs such as debt servicing, security, planning and maintenance, those can legitimately be assigned to the project and taken into account in the lender's calculations. Keeping a clean ledger from day one is worth real money later.
What Development Finance Actually Costs
Interest rates are dictated by risk, or implied risk. Size matters, and risk and leverage are inextricably linked: the higher the leverage, the more risk the lender carries and the more you pay for it.
There is no single answer to "what rate will I get", but broken down by lender type and leverage range, typical pricing on loans over £1m looks like this:
|
Lender type |
Typical LTGDV |
Typical LTC |
Typical all-in rate |
|
Mainstream banks |
50%–60% |
65%–75% |
2.5%–4.5% above cost of funds (SONIA or BoE) |
|
Challenger banks / specialist development funds |
60%–70% |
75%–90% |
3.5%–5.5% above cost of funds (SONIA or BoE) |
All-in means the total rate paid, combining the lender's margin and their cost of funds. Mainstream banks are the most conservative and therefore the cheapest, and are generally tighter on LTC. Challenger banks and specialist funds are more aggressive on leverage and slightly more expensive, but generally more flexible.
Loans Under £1m Cost More
The labour cost of sourcing and underwriting a £10m development loan is much the same as a £2m loan, but with five times the return. Analysing ten £1m loans takes ten times the resource for the same return as one £10m loan, so the higher relative cost of underwriting smaller loans gets passed on.
The sub-£1m market is still served by mainstream and challenger banks, but the biggest presence is specialist development funds and bridging lenders that have moved into development. Expect pricing around 1.5% to 2.5% higher than £1m-plus loans.
Fees Change the Picture
On top of interest, the total cost normally includes:
- An arrangement fee of 1.25% to 2% of the gross loan
- An exit fee of 1% to 1.7% of the gross loan
Most lenders have a minimum annualised rate of return on their capital, and it is the combination of all three costs that gets them there. If a lender is charging a lower interest rate than peers at the same leverage level, expect to pay higher arrangement and exit fees, sometimes called in and out fees.
True Monthly Cost
Three moving costs make like-for-like comparison difficult, which is why Brickflow uses True Monthly Cost:
(Interest rate / 12) + (arrangement fee + exit fee) / number of months
For example: (9% / 12) + (3.5% / 18) = 0.94% per month
Comparing headline rates alone will mislead you. Comparing True Monthly Cost will not.
How to Stretch Equity Further
Not having a hefty deposit does not mean the end of an ambitious scheme. Alongside getting the capital stack right, there are several proven ways to stretch equity.
1. Shop the market
The default setting for many developers is to stick with a tried and tested senior lender. But with deposits varying from 10% - 40% of total costs, the required deposit on a £5m scheme could be anything from £500K to £2m. That is a huge and potentially deal-breaking difference.
If you only have a relationship with one lender who requires a higher deposit, it could mean tying up an additional £1.5m of equity, blocking investment in other schemes and preventing progress to bigger sites sooner. The relationship tax is real, and easily avoided with market comparison software.
2. Leverage networks carefully
The best developers are good at bringing in the right partners. It is unlikely that a single source of funding is the most cost-effective route, so friends, family, and a wider professional network are all options for raising equity.
That said, do not be too generous with profit share. You are the driving force behind the development, and without you it would not be happening at all. Worth remembering when assessing funding options, because when a lender demands a large deposit, the obvious route of bringing in a profit-share investor often proves a false economy: equity is the most expensive piece of the stack. Experiment with loan structures before you sign away profit.
3. Leverage the planning process
Buying a site without planning permission and securing it later adds value in the form of sweat equity. Securing consent is not easy, so good lenders take it into account when assessing an application.
Buying pre-planning has a second benefit: it can reduce the profit owed to investors. If enough value is added, initial equity can be repaid when development finance for the build stage is raised, meaning investors are paid a percentage of the profit on the planning uplift rather than a share of total profits at the end.
3. Second charges
Second charge loans use the equity in background portfolio properties as security for another loan, even where there is an existing mortgage, which is a good way to conserve cash. Second charge lenders are set up to move quickly, making them a strong alternative to remortgaging or draining cash reserves.
Lowly geared BTL properties are ideal candidates. Lenders can even take a second charge over multiple properties to create an overdraft-type facility, drawn as and when needed to raise a deposit.
5. Deferred land payment
A landowner can agree to receive part of the payment once the properties are built and sold, usually at a higher price as the trade-off. Known as deferred land payment, it can sometimes be used to make up an equity shortfall.
The development lender takes first charge over the land and funds all of the build costs plus a portion of land acquisition costs. Because the site is worth more than has been paid for it so far, the lender is given security on a de-risked position, which opens up access to greater value projects with smaller deposits.
The landowner will normally want a second charge behind the lender and must accept being repaid only after the lender. Not every lender or vendor will agree, so a broker and estate agent with the right relationships help. A small profit share can sweeten the deal if needed.
The Practical Takeaway
The cheapest headline rate is rarely the cheapest deal, and the deposit a lender demands has a far bigger impact on your returns than the margin they charge. Model the whole capital stack, compare lenders on True Monthly Cost rather than rate, and treat the deposit requirement as negotiable across the market rather than fixed.
Want to see how your own deal stacks up? Model your scheme with LandTech's Appraisal Tool, featuring Brickflow.
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