Entrepreneurs thrive on their ability to identify and satisfy demand in a particular market. And from an entrepreneurial perspective, there can be few markets that are so self-evidently rich in pent up demand as residential property.
Estimates of that demand vary, but the settled view of Government is that the UK needs to build around 300,000 new homes every year. Indeed that figure has become an official target.
The opportunity for entrepreneurs is clear. All across the country, new developments are springing up, and in very many cases they are being executed by large and mid-size builders. But that is certainly not the whole picture. Smaller developers and entrepreneurs are also engaged in development projects. That might mean converting existing residential or commercial properties, or building new houses. These projects depend on available finance.
The good news is that finance is available – often in the form of development loans – from banks and specialist lenders. And given that demand is clearly present in the marketplace and (equally important) that development land also has a value, an entrepreneur with a good business plan, and possibly also a track record in the property sector, should be sailing in front of a fair wind when it comes to raising capital. At least in theory.
The Realities of Property Finance
But it is important that entrepreneurs new to the sector understand the realities of the finance ecosystem, and in particular, the formulae that lenders tend to apply when deciding how much capital to advance. And in the first instance, what we are really talking about is the ‘loan to value’ ratio.
At its simplest – when a property exists and can be sold on to residents or another company – a lender will look at the sale value and offer a loan based on a percentage of the estimated amount. Typically, a lender might advance up to 80% of the purchase cost. That’s enough to provide a certain amount of leeway should the entrepreneur run into problems that result in a repossession. If property prices fall, the lender can still recover all or most of the money, so the risk is covered.
So the imperative here is to ensure that the funding requirement not covered by the lender can be met by the borrower.
Things get a little bit more complicated in the case of developments where work has not yet begun on the properties, or when the project is underway but not yet complete. In development situations, the sum offered by the lender will be based on an estimated future value. What that means in practice depends on the status of the project. For instance, if an entrepreneur is buying land, he or she may have to find up to 50% of the estimated value. Lending is then phased through the development and when it comes to funding the building work, a lender may advance a much larger percentage of the sum required.
Typically, however, a lender will also look at the total project and take a view on what percentage of the total cost will be covered by the loan.
There are other factors to be taken into consideration. For instance, a lender may charge interest in a monthly or annualised basis, which sounds simple enough. However, in some cases a monthly interest charge could be based on the sum drawdown at that point in time, while other lenders will apply the charge to the total sum that is to be released over the entire development cycle. Clearly this will have an impact on costs and therefore profit.
So for the entrepreneur who has perhaps dipped a toe in the waters of property investment by acquiring a portfolio of buy-to-let houses, there is a lot to think about when looking at a development project.
It’s important to be agile. For instance, the bridging finance available to fund development projects can be expensive, so at some stage, refinancing might be worth considering. There is also the question of what happens if costs overrun and an existing lender is unable or unwilling to provide the additional capital. A new finance provider may be required.
The finance options are opening out. In addition to traditional lenders, the rise of alternative finance platforms has seen new sources of capital coming on stream. There are, for instance, Peer2Peer lending platforms that specialise in property.
For its part, The Route – Finance’s Private Debt Platform is focused on supporting entrepreneurs and SMEs across a broad range of sectors, with funding provided by a community of High Net Worth individuals. To date, The Route have supported a significant number of property development projects. Because The Route’s Membership, aided by the due diligence of The Route, are accustomed to assessing risk, the platform can facilitate loans in ‘special situations’ that might not appeal to more traditional providers. The key is the viability of the project.
To find out more: 020 3141 9040