How to finance your property development

When you start out as a property developer, it’s important that you have the capital behind you to finance your initial development. But where does that initial funding come from? And how do you go on to provide successful and stable long-term finance for your growing property development business?

Daniel Morgan explains the key ways to finance your property development.

The difficulty of sourcing funding as a new developer

When you’re first starting out as a property developer, it can be difficult to find the finance you need. And, on the whole, that’s down to a current lack of experience.

Lenders want to see evidence that you’ve completed a few deals before they will even look at you. The banks won’t consider lending you money until you have that experience, but that’s a rather ‘chicken and egg’ scenario. You can’t get funding to develop your property, because you’ve never developed a property. It can be very challenging to get your development off the ground when you’re starting out.  

How funding works for the more experienced developer

When (and if) you get a few development deals under your belt, you have more options available to you, and routes to finance should become easier to find.

The classic funding set-up for most developers is that you have a pot of money to invest in the project, but not enough to fund it in full. In that scenario, you need a senior lender to lend 60-70% of the money, with you funding the difference.

Many developers, however, don’t have adequate funds to make up that difference, so you might need a mezzanine funding arrangement to help you get together the remaining 30-40% of the finance. When you’re low on capital, this can be a lifeline, but you do need to think about the impact on your margins, loan payments and liabilities.

The mezzanine lender will take a big chunk of your end profit. For a mezzanine arrangement to be viable, you need the development to create a decent profit. This allows you to pay back your lenders while also hanging on to a decent profit margin on the project.

Understanding your numbers and gross development value

Mezzanine lenders will want to see a full breakdown of your costs and development budget before they commit to an arrangement. To do this properly means having a good handle on your development numbers, in particular the gross development value on the project.

Gross development value (GDV) is a property metric that tells you the most accurate projection of what your property or development will be worth on the market. It’s a vital metric for working out the total you’re likely to make at the point of selling the development – and, as such, how much profit you’ll make on this particular project.

You would also usually get a surveyor to look at the development to help you get a better understanding of the financials.

The surveyor will look at:

• Potential purchase price and GDV – so you have a realistic assessment of the final worth of the development and can factor this into your financial planning and funding strategy. This information will be vital to know when approaching a lender for finance.
• Risk assessment – in property funding, all parties are continually trying to limit their exposure, so risk assessment is vital. The surveyor will think about where the risk areas may lie and what the risk level may be if the lender ever has to seize the site.
• Cost assessment – your site surveyor will also report on the costs you’re intending to cover, to ensure you’ve made an accurate approximation of the raw materials, labour costs and site expenses needed to get the development over the line.
• Keeping you on schedule – the surveyor will also keep tabs on the site as you begin developing and will provide a certificate to say that you’re on schedule and that the right level of work has been done – always keeping the funder in kilter with their exposure.

A changing and evolving property market

The key driver behind any property development is to get a return on your initial investment, but knowing what your new or renovated property will be worth is tricky in the current market.

The value of many properties was stung from the previous credit crunch and this ongoing economic recession is likely to have a significant impact on property values. Valuations were poor during lockdown, but had been picking up before the extra autumn and winter restrictions were announced. Value is very likely to drop during a second wave, and the outlook as we head towards Christmas and the end of 2020 is very hard to predict in an accurate way.

One thing we have seen in the market is that there’s a big demand houses with gardens, rather than flats, especially post-lockdown. People have got used to working from home and mixing that with occasional commuting. They’re willing to do a longer commute a few days a week to have a bigger house, with a bigger garden, somewhere out in the suburbs, rather than in a city centre.

The property market is likely to evolve significantly post-Covid, especially in the commercial, retail and residential sectors. I have clients with blocks of flats where there is demand, but finance is an issue. You’re usually looking at first time buyers, or aiming at investors, with these apartment developments, but deposits are a 10% minimum and even these deals are so oversubscibed that lenders are having to release these in limited numbers.

So, deciding what sector to focus on, and how you will rework your strategy to fit the post-Covid market is vital to the success of your developments.  

Knowing where to start as a developer

Where do you start as a developer? And what’s the best way to dip a toe in the water?

Most developers will start with refurbishments (refurbs) and renovating existing properties for a sale. You might be aiming to refurb and sell, or going for buy-to-let. But you have to let your lender know the purpose of the development prior to applying for funding.

Working on refurbs gets you plenty of experience in the sector, and that helps greatly later down the line. Refurbs are easier from a knowledge perspective too. You aren’t competing with property professionals and large property companies quite so much – most refurbs will be people dabbling in property development.

Specialist property lenders can be convinced more easily if you have a good track record, and getting involved in refurb projects is a good way to do this.  

Working with a property adviser

At the early stages of your property development career, it’s useful to work with a property adviser – someone who knows the sector, understands the common challenges you’ll face as a developer and who can help you find the finance you’ll require.

Property is like steering a ship – you turn the wheel but it takes a long time to turn. You can’t predict what will happen and you can’t change direction that quickly. We offer advice from the start, helping to plot the best possible course for your developments.

This adds value in a number of areas:

• Providing the right metrics – as the developer, you work out the initial figures for the project. But we can put those figures into a model to show you the important metrics that will need tracking over time – things like your monthly spend, your costs, your interest payments etc.
• Answering your property questions – as a practice, Haines Watts Esher has been working with property developers for years, so we can help answer all of your property and development questions when you’re setting up.
• Introducing you to our network – we can also introduce you to lenders, solicitors and wealth management specialists, so you have the full breadth of the Haines Watts’ network at your disposal, whatever area of advice you’re looking for.
• Helping with Cost Variance Reporting – during the project, you’ll need to look at Cost Variance Reporting (CVR), comparing actual spend to your budget. This helps you keep watch on your monthly amounts to ensure you’re in line with where you expect to be.

Some businesses may have a surveyor on site to look at CVR, as they know what’s been happening on the project. We put it all into a proper reporting package for you, so you can see the numbers easily, alongside your regular management accounts and key metrics.  

Riding out the current post-Covid challenges

We’re experiencing tough economic times at present. And, as a developer, you have no control over the macroeconomics. Property prices, site costs, labour costs and your end return will all go up and down over time – often beyond your control, being the risks at play.

What you CAN do is have your budgets clear, your forecasting done, and include some sensitivity analysis and scenario planning into your initial planning. This means taking your initial figures as a starting point and projecting them forward to look at the best and worst-case scenarios. So, what happens if your costs go up by 20%, or what happens if your finished property doesn’t sell for two years? It’s good to have that all planned out, to know if there’s enough meat on the bones of the project, or when you might need to exit the project.

We’re your sounding board over the course of the development. We know the lingo, have the funding contacts and the property development experience to provide you with the right advice.

Talk to one of our Esher property advisers about how to finance your next property development.