What are the different types of development finance?
There are a range of property finance options available for investors, developers and landlords to access:
Property finance for developments are generally short term loans to cover the costs of converting an existing property or developing land into flats, houses in multiple occupation (HMOs), or alternate uses. It is normally advanced as a loan, secured against that property or land asset.
Used to purchase commercial property such as retail units, offices, industrial units or to even consolidate larger Buy-to-Let portfolios. Principally working in the the same way as a private mortgage to finance the cost of a large purchase.
Auctions can be a quick way to get a property at a discounted price, but if you don’t have the capital to hand to finance the full deal there are lenders who specialise in finance for property purchases at auction.
Bridging finance or development finance loans
Both of these options are generally to facilitate short-term funding to cover costs of building and development costs. Different lenders or investment platforms will vary these definitions for their own criteria but more generally bridging finance will facilitate the completion of a project as cash flow tightens, and development finance will allow for more major work such as heavy refurbishment or renovations, and most typically for ground-up development projects.
One common structure of development loans is that of Mezzanine Finance that overcomes a developers financial shortfall to ensure project completion. For example If a development project will cost £2,000,000, and the developer is investing £400,000 of their own capital, and a First Charge lender is willing to loan £1,000,000 to that project, there will be a gap of £600,000. A mezzanine finance loan will cover this shortfall on a Second Charge basis.
Learn more here about how development loans are structured.
What is the difference between a first charge and a second charge loan?
When taking out property finance the borrower, often a developer, gives charge of the property to the lender. If the developer defaults by not repaying the loan per the agreed terms, then the lender can sell the property or land in order to recover sufficient funds to repay the loan.
When a developer obtains multiple finance options on a project these are prioritised into First Charge and Second Charge status. The terminology effectively relates to the priority given to the lenders involved – and for investors gives a clear indication of the risk profile involved in a project.
The First Charge is given to the first lender to realise repayment from liquidating the property assets. The Second Charge lender will be able to recover payment when the liabilities of the first charge lender are recovered and if there is sufficient value remaining. Second Charge lenders will charge higher interest rates, reflecting the higher risk, and in turn investors can expect to realise higher returns by investing into a Second Charge debt deal.
It is important to note that Second Charge lenders have the same rights to recover their loan as the First Charge lender. The relationship between First and Second charge lenders is usually governed by an inter lender agreement.
What is the Redemption period for a development finance loan?
The typical term of development finance is 12 to 24 months as they are typically for ground-up or heavy redevelopment projects. Development finance loans generally don’t pay any interest during the term – all the interest is paid along with the capital of the loan at the end of the term.
Bridging finance loans are generally for up to 12 months with an industry average of 6 to 7 months. Bridging finance loans generally will have regular interest payments.
Read more about investing in development loans here.