Property development opportunities take many forms, so naturally enough, there are also numerous finance options. When preparing to borrow to fund a project, it’s important not only to match the source of finance to the project, but also to think about what the lender will require before signing off on a deal. So depending on the nature of the deal, how do you prepare?
Depending on the project, the finance options include buy-to-let mortgages, commercial mortgages, bridging loans or development finance.
For those putting a toe in the property investment market for the first time by purchasing an apartment or house to rent to tenants, then a buy-to-let mortgage is the obvious solution. Essentially the arrangement is similar to an ordinary mortgage. However, the fees are higher and the buyer will have to raise a bigger minimum deposit than would be the case with normal mortgage – usually around 25% of the value. The monthly cost may be lower though as most buy-to-let loans are interest only.
For more ambitious projects – say the creation of a portfolio of rented homes, a commercial mortgage might provide a better solution. Designed primarily to enable businesses to buy shop, factory or office space – these can also be used by professional landlords who are seeking to rationalise their borrowing across multiple residential properties. n that regard, the factor that is most likely to determine the choice of solution is the scale of the project.
Property development – whether refurbishment or something closer to full scale building project – invites consideration of bridging and development finance.
Bridging finance is probably most appropriate for projects that can be completed over a short timescale – say the refurbishment of a block of flats for sale or rental or the conversion of a small office to residential units. When the project is complete the properties can be sold off and the loan repaid. Alternatively if the objective is to rent out the properties, the loan might be refinanced.
Development finance serves a similar purpose. The difference is usually in ambition of the project. A ground up build, for instance, would require development finance.
What the Lender Wants
So what criteria to lenders apply to prospective borrowers? In the case of simple buy-to-let transaction, the answer to that question is relatively simple. The borrower should be able to demonstrate an ability to repay the loan. Typically, the finance provider will want to see evidence that the property can be rented out for 125% or more of the monthly mortgage costs. The loan will be secured against the property itself.
The Business Plan
It becomes a little more complicated in the case of larger development projects. As with any commercial proposition, the prospective borrower – be it an individual or a company – should prepare a business plan that shows a command and understanding of the development costs, a realistic timescale and full account of how and when the loan will be repaid – for instance, when properties are sold. The lender will also want security against the loan. Usually this takes the form of the development property itself but it may also include other properties owned by the developer.
This is essentially a due diligence process, and as such, the lender will want to be assured that all the necessary planning permissions are in place and that the developer has all the required legal documentation and agreements in place to support the business plan. On a more personal level, the lender will assess the developer (whether an individual or a company management team) in terms of track record and credit worthiness.
In other words, the process of borrowing to fund a property deal is similar to seeking debt for a business in any other sector. There are some special factors, not least that the value of a property under development may well exceed the sum sought under a bridging or development loan. That should make it easier to borrow under a development finance arrangement.
On the other hand, in a development that involves a ground-up build the land may be worth less than the cost of construction. The lender may therefore agree to fund part of the project, with the developer putting up the remainder. Thus it is important to think in advance about realistic loan to asset value scenarios and where the funding not covered by the lender.
With a business plan prepared, the next step is to look at the lender options. And as the alternative finance market has opened out, there is now more scope to seek property finance through marketplace platforms, including The Route – Finance’s Private Debt Platform. The Route provides funding for a wide range of businesses and property development has emerged as an important sector.
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