How To Fund A New Development

THE QUESTION

I’m looking for advice on development funding. I have been offered the chance to put in one third for some land - which has planning permission for four barn conversions plus a new build plot. The purchase price of this land has been offered to us for £750k with a GDV for the houses of approx. £3.5m. 

I have a few BTLs, but this is the chance for me to get into development. I would need to borrow £250k for the purchase and more for the build costs and associated fees, but this gives great returns. 

What would be the best way to borrow this money? 

THE ANSWER

Development finance is the type of finance used in this - it’s a 'does what it says on the tin' thing - you have a development that you want to finance.

Development finance lenders are not going to be the major banks, or household names. It used to be but the major banks quit this type of lending in the 2008/09 credit crunch and have never got back in, in any meaningful way.

From the lender’s perspective their key criteria is - how easy will it be to get our money back? Anything that they perceive makes that more difficult reduces what they will lend, what they will charge if they do lend, or whether they will lend at all.

Having a few BTLs cuts no ice with these lenders - the skills of being a landlord, even of doing a few refurbs, doesn’t equip someone (in their view) with being able to: 

a) Build out of the ground 

b) Do a major conversion.

Whilst they may cut some slack for a modest single unit new build, a multi-unit project of this size and value would be considered bridge too far. They see a very real risk that the borrower could flounder mid-project and leave the lender to pick up the pieces. 

You would need a business partner with that level of construction experience to be viewed as a credible borrower – and someone as a proper partner, not just a contractor. 

Get that angle sorted and the next step is to find out what you can borrow.

Standard terms are 100% of build costs. Lenders need to know that the project will get finished as that ensures they get their money back from sale or refinance.

They will fund a chunk of the purchase price too, but want the borrower to cover the fees. They will require some 'skin in the game' or 'hurt money' to ensure that the potential loss of the borrowers capital injection keeps the borrower focused on making a decent profit – from your question it looks like you’re investing £500k of the £750k purchase price, this will more than satisfy lenders. They won’t need the cash input to be this big, so reduce it so all fees are covered by the borrower.

If the two other partners are expecting you to match their input then you have a problem, as individually you can’t borrow the deposit and if their barrier to entry is you matching their cash in. You are going to struggle.

In relation to your observation that "This gives great returns" - that could be a matter of opinion and when you want to borrow money, it’s the lenders opinion that counts - 20% of GDV would be the absolute minimum that lenders expect to see from a project and that is net net i.e. after ALL costs are deducted.

That means a £700k minimum profit after purchase, works, finance costs and professional fees are deducted. If the site is costing £750k, that leaves no more than £2m to cover everything. 

In reality, a profit of at least £1m would give greater lender comfort - and that would be considered a 'great return' and not anything less – time for you to do your sums – and probably some serious research to justify those figures.

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