Development Finance Guide
When it comes to development Finance, make sure you ask questions! Asking questions can save you and your development unnecessary costs and issues.
If you buy something significant you should ask questions. A car, for example, is generally a big purchase and you want to find out if it’s right for you before you buy.
You will ask about the horsepower, the spec, the mileage – lots of small things that make up the package and that ultimately helps you decide if you want that car.
With that in mind, why is it so many don’t ask crucial questions when it comes to development finance?
I speak to clients every day that have made assumptions, which have left them open to taking out a loan that isn’t right for them and will cost them thousands more than they expected.
Make sure YOU AREN’T that client!
The chances are you will be comparing one quote with at least one other, doing this may or may not give you the information you need to make an informed decision. Development finance costs can run into 4, 5 or even 6 figures depending on your project, so make sure you ask questions.
The useful guide below has been designed to guide you through the development loan process If your initial quote doesn’t include these points, you should be asking yourself how competent is the broker providing the quote and what else might be being hidden?
Before the Quote.
Some lenders will want to come and meet you at the site. They will have information about the project, so they know a bit about it, but they want to come and see you, the client and location, in person.
Some may charge for this, though it may take the place of a valuation report, so the cost compared to other lenders may be a moot point – it might even be cheaper.
This visit could lead to your application being declined, so it is a good idea to make sure that the lender has as much information as possible before they come. If you send some photo’s of the site and adjoining property or sites, for example, it helps build a picture and gives them more to work from.
Initial Inspections and Professional Reports:
When you get an initial quote from a broker or lender, the cost of inspections or professional reports may not come up, unless you ask for the information.
Most will want a Q.S. (Quantity Surveyor) or engineer to go to the site, and through the project figures. Most also require a valuation to be carried out.
That may not be all, depending on the content of these reports, you might need to provide other information the lender deems necessary.
These reports are required as part of the application process, so in some cases, the content of the reports could lead to your application being declined. That, of course, means that you have spent money but might not get the loan you need.
As with all the other costs, though, it’s a legitimate cost of application.
It is worth keeping in mind although you paid for a report it doesn’t mean you own it. So, a valuation done for one lender, for example, is not necessarily going to be useable if you change finance provider part way through an application.
Paying a professional to do a report on your site or project is not a bad thing by any means, a fresh pair of eyes with an impartial view could be invaluable. If you are very experienced, it might not be a welcome cost but most would agree that spending a few pounds now, relatively, is better than losing £000’s later.
For newer developers, it could be the best £1,000 or so you’ve ever spent. Are you sure the site doesn’t have issues with drainage, bats and badgers or invasive weeds? You might even find out the ground works will cost way more than expected – better to know now.
Some lenders will want you to pay a fee on acceptance of offer. Once you sign that offer, before the full underwriting begins and before the legalities start, you have to pay a portion or all of the arrangement fee.
It doesn’t guarantee that you’ll get the loan but look at it from the lender side. They will start committing time and resources to the your application and cost do need to be covered.
Not all lenders do this, by the way, some will only charge you the fee when you have received funds, which may seem to you to be a much fairer way to work.
If the application falls down, you may or may not receive all or part of the fee back. If you are going with one that does need a commitment fee, it is worth asking the question.
Taking the figures you are given at face value could leave a number of costs and potential issues you aren’t aware of.
Non Utilisation Fee:
Everyone is used to being quoted an interest rate, for many it’s the first question they ask (rightly or wrongly).
Most lenders will charge you interest based on the amount you have drawn down but there are some development lenders that will charge you a rate for the money that you don’t use.
Most development lenders will charge an exit fee of some description. It could be an additional months interest, it could be much more. The main ways of charging are either on the loan balance or Gross Development Value (GDV).
This is pretty straightforward – Your exit fee is calculated based on the amount you owe at the time you pay it back. The good thing here is that if you end up using less than you expected to carry out the project, you will be charged less, so your development will make a larger profit.
This one is much more expensive and can potentially skew the overall cost of a loan significantly.
In this situation, you pay a fee based on the end value of your development project, determined by the valuer at the start. This is one of the main reasons that you should not focus solely on rate and should always ask what the exit fee is based on.
The cost is felt most by those projects that only need a small loan amount compared to a high end value – imagine you wanted £200,000 with a GDV of £1m, that could be a massive fee relative to the amount you need.
Sometimes the exit fee (and arrangement fee for that matter) can be on a per annum basis, making it more expensive than you might think. Most though, charge it as a set percentage.
Other options for the exit fee can be based on the total amount borrowed or the amount you actually get for the project when you sell it.
You probably already know that development loans are broken down in to tranches of money that you take as the build progresses. Different lenders will have different ideas of when that should be, which will impact on the running of the project.
There is generally a professional inspection at each draw downs stage, which, of course costs money. It may not make much difference to the cost of the loan overall but it can add a couple of thousand, so it’s definitely worth knowing about.
It’s not just the cost though. Depending how long it takes the lender to arrange the draw down of funds to reach your bank, can impact how long the project takes overall. This in turn may mean you need to keep the money for longer than expected, so incurring more interest charges and possibly running up against the term agreed with the lender.
With a development loan, it’s not always just about the cost – service really does matter!
A starting point is to ask how often you will have to take draw downs. You don’t want too many as this will cost valuable time and money for inspections, which can be disruptive to the smooth flow of the project.
The amount you can take per draw down is another important consideration. Too small an amount will stretch out the time a project takes as you wait for inspections, and then for the lender to agree to carry on the funding.
Ask if the lender charges a fee for work required when organising draw downs. Some do, some don’t. Again, the cost won’t necessarily make or break the deal but it is worth knowing how much you are likely to be paying.
All developments will be monitored by the development finance lender. To do that most will want a QS, Engineer or Valuer to visit the site before releasing further monies.
They have to be sure that you are doing all the work correctly and in-line with planning and building regs, they also have to be sure that you are actually spending the money on the site they are funding.
As with the initial inspection, the borrow covers the cost and all professionals that need paying to do their job. You might think it is unnecessary as you know more than the person inspecting your work but it’s a price of borrowing money.
On the other hand, if you are relatively new or you always use a main contractor, it is independent verification that all is going as it should. The process can catch issues before they get out of hand, so don’t just view these inspections as an expense you could do without.
Some lenders may well insist on monthly inspections, regardless of whether you want a draw down or not.
Service is an often overlooked consideration for financing projects but with draw downs it can be crucial. You have trades to pay, materials to buy and if a draw down takes too long, you can find yourself falling foul of your colleagues and missing dead lines.
Ask the lender what the process is and how long they would expect it to take. You can factor this in to your build timetable to make sure you aren’t left short.
How Do You Qualify?
Development funders have different ideas of what is required of you before they will release the next stage payment.
For some, the payments are in arrears, based on the amount you have spent and nothing more. If you over spend the agreed budget, it is coming out of your pocket.
Others want to see the value of the site increase, so they send out a valuer. The potential issue here is that if the lender doesn’t think the site has gone up in value enough, they won’t lend any more money.
To move the project on, again, it’s coming out of your pocket, which may or may not be feasible. Without your own capital, the project is stuck.
Another method is to have a professional check the work done so far and confirm that it is satisfactory. In this situation, as long as you know your builder or you know you have done it right, there is no reason for the lender to withhold the next stage payment.
The issue of how you will qualify for the next stage payment and the method used by your lender, is especially important on a “tight” project. When you are borrowing to maximums, there is no margin for error.
What happens if you go past the term?
We can all be caught out by something that disrupts the ‘normal’ run of the mill, even if we have done the same or similar sorts of schemes many times before.
Development projects are no different.
For example if we are talking about new build projects, the weather can extend your build time and if you haven’t got a long enough loan term, this can be a problem.
Apart from the actual time to do the build, the bit you have some control over, what about the bit you can’t control? Far too many developers and builders don’t think about the time needed to achieve a sale or arrange a buy to let mortgage.
As many found in the credit crunch, if the market turns, you could find your buyer is no longer able to get their previously agreed mortgage. Or, it could be that buyers are non-existent at the time you finish your build.
How quickly you get a sale is heavily reliant on market conditions. You could wait months for someone to turn up that wants to buy from you, or in a buoyant market, your development could fly off the ‘shelf’.
What if the buyer finds something else, or something beyond their control means they can’t complete as you hoped?
Factors beyond your control will impact on the amount of loan term you need.
At the outset, you can have the choice of a shorter term loan that looks more attractive but it comes at a risk. If you do go past term, you will likely find yourself on the receiving end of much higher rates and potentially extra, unexpected, fees.
Not all lenders do this, there are those that will be flexible within reason. So, please bear in mind that while one loan might look great on day 1, it may not offer you the flexibility you need, and you may well be really grateful of a lenient and flexible lender in unforeseen circumstances.