Development & Construction Finance

Want to know how development finance works? Here’s a complete guide to explain this type of property financing and where you can get the best terms and rates.

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Home Development Finance Development & Construction Finance
Pete Mugleston

Author: Pete Mugleston

Mortgage Advisor, MD

Updated: March 8, 2024

If you’re planning to embark on a building project, perhaps a new construction or renovating an existing property – development finance could be the funding solution you need.

This guide explains everything you need to know about how these loans work. We’ll cover all the different property development options, how to secure financing, and where to get the expert support you’ll need to get the best rates.

Keep reading for a complete explanation or click on a link below to jump straight to a section…

What is development finance?

It’s a type of short-term, interest-only loan. Similar in many ways to bridging loans, except for the way in which borrowed funds are paid out (in stages rather than a lump sum). Development finance is commonly used by developers, landlords, and investors because the flexibility means it can be used for residential, commercial, or mixed-use properties.

Is it different to construction finance?

Strictly speaking, construction finance refers only to funding for the construction stage of property development, but it comes under the broader heading of development finance. This covers both the initial site purchase and the subsequent work, and the terms are sometimes used interchangeably.

Affordability for construction finance involves working with several unknowns but the key metric lenders use to establish how much to lend is based on a figure called the gross domestic value (GDV)

The GDV of the property refers to how much it’s expected to be worth once all development works have been completed, plus the estimated costs of the project.

How does development finance work?

It allows you to borrow on a short-term basis, with funds paid out to you in drawdown stages as your property development project progresses, known as ‘tranche drawdowns’. In most cases, lenders will carry out periodic re-inspections of the site before each payment is made, similar to a self-build mortgage.

This is to make sure you remain on track with the schedule of work (SOW). Like with most interest-only borrowing, one key requirement is that you’ll need to prove a viable exit strategy – your plan to pay back the debt at the end of the term. This would usually be done by refinancing or selling the property once the development project has been completed.

Although development finance draws similarities with bridging loans, the ability to borrow much larger sums is a major advantage. Especially if you’re hoping to buy a piece of land or embark on a sizeable construction project. But, even though development finance can be used for both a site purchase and construction costs, different terms and rules can apply to each use.

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Eligibility criteria and deposits

Each situation is going to be completely unique. Eligibility for development finance will depend on your individual circumstances and the property development you’re planning. But, below are some major points lenders consider, along with typical deposit and loan-to-value (LTV) requirements.

  • Deposit: the deposit size and resulting LTV for development finance will first depend on whether you need funding for the site purchase and also the construction. If that’s the case, most lenders will want a deposit of between 25% to 40% of the site value. So, your LTV would be in the region of 60% to 75% for the land. Then, some lenders (but not all) will offer up to 100% LTV development finance for the actual construction and development costs. To do this, you’d need to use another high-value asset as security for the loan. Or sometimes, agree to a profit-sharing (joint venture) finance arrangement.
  • Exit strategy: the strength of your exit strategy will play a key role. Since you’ll only be paying interest on the development finance, lenders will want to see a solid plan for paying back that debt at the end of the term. Proof of a solid exit strategy, such as your ability to sell or remortgage the development will be an important factor.
  • Development experience: typically, finance will be easier to get if you have past experience with a property development project. A proven track record will show lenders that you’re serious and their investment is in safe hands. But, there will be a small number of lenders open to financing your project if you’re a first-time developer.
  • Type of interest and term length: some lenders may give you the option of a fixed or variable rate, but others won’t. Also, even though this is a type of short-term finance, property developments can take time, so term lengths can range from around 3 to 36 months. The type of interest and loan length can both impact your rates, so it’s worth dealing with a lender that suits your specific property development needs.
  • Higher rates: it’s worth keeping in mind that some lenders offering development financing options will charge higher rates of interest to offset the potential risks of all that can go wrong with a significant property project. It’s important to make sure you are introduced to the right lender if you want to keep your borrowing costs down.
  • Type of development: there are lenders who specialise in specific areas of development finance, for example – hotels, first-time developers, overseas projects, or even small property development loans. This is why it’s so crucial you speak with the most suitable lender from day one if you want to get your project underway with the right type of development finance.
  • Early repayments and additional fees: some lenders will allow you to overpay or make earlier than scheduled repayments with no extra fees, but others won’t. You should also take the time to note any additional charges involved such as an exit fee (usually 1%-2% of the total loan), broker fees, valuation charges, and arrangement costs (sometimes 1%-2% of the gross facility).

How to get development finance

Your first recommended step is to speak with a broker who has experience arranging development finance. If you make an enquiry with us our free broker-matching service will be able to match you with the right advisor. 

Your development finance broker will then be able to help with the following: 

  • Preparing your business plan and exit strategy: A lender will want to see a detailed plan outlining the schedule of work for the development along with a clear exit strategy once the property has been completed. Your broker will be able to help gather together the information required for your specific development plans. 
  • Working out how much you’ll need to borrow: With their experience in arranging loans for property development, your advisor will be able to help you calculate how much you need to borrow for your project. Looking at the potential gross development value (GDV) and all the associated costs. 
  • Finding the right lenders: Development finance is quite a specialised form of lending. Your broker will be able to quickly identify those lenders who work in this area of finance and currently offer the most favourable terms. This will save you a lot of time and, potentially, some money too. 

How much will a development finance broker cost? 

It depends on the complexity involved with the application but, typically, development finance brokers will charge somewhere between 0.75%-1% of the amount borrowed, usually payable directly to the broker once the formal loan offer has been agreed.

Some brokers may ask for an administration fee payable upfront as part of their overall compensation before submitting an application to a lender. 

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Types of developments you can fund

As long as you deal with the right lender, there are fairly limitless possibilities you could potentially use your funds for.

  • Residential buildings – This could be for a single or multiple houses, or maybe something like a residential apartment block/multi-unit accommodation.
  • Commercial projects – Financing for anything with a commercial development aspect such as offices, retail stores, industrial facilities (warehouses, factories), medical centres (hospitals, nursing homes), hotels, pubs, restaurants, and cafes.
  • Regeneration or conversions – You might want to carry out light refurbishment which is mainly aesthetic, or more significant renovations to a building that involves structural changes.
  • Ground-up development – This would involve starting with a plot of land and building from scratch, or perhaps a complete build using just some original foundations or stonework.

How much you can borrow

When development finance lenders are calculating how much they’re willing to let you borrow, there will often be a variety of methods used for working out affordability. The most common is for the lender to base it on the project’s ‘Gross Development Value’ (GDV) plus costs. The GDV is the estimated value of the completed development.

So, a typical development finance deal may involve a lender providing 70% GDV plus 75% to 100% of costs. But, it’s important to realise that each lender will have its own borrowing limits. Some may also have a minimum borrowing figure and others will only offer the best rates for loans that fall within a specific size range.

The smallest property development loans can be around £50,000 and the largest sums for development finance can go as high as £50 million. But, there can be some variation in these figures with a tailored borrowing arrangement.

 

Available lenders

The exact lenders available will depend on a whole host of factors, including where you’re located. To give you an idea of some lenders who offer forms of development finance, here are a few examples:

  • Paragon Bank – First charge lending up to 70% GDV and 90% of costs for loans between £450k to £35 million but only available in England and Wales.
  • BLG – Provide development finance loans of between £1 million and £15 million for residential or commercial projects. But, only for term lengths of between 12 to 24 months with a 70% maximum LTV and up to 85% of costs.
  • Aldermore Bank – Finance for property developments between £1 million and £25 million, lending up to 85% loan to cost, or 65% of the GDV. Maximum term length is 30 months and a fixed rate of interest is decided case-by-case.

Specialist lenders for construction finance include Mint, Paragon, Octopus Real Estate and Hope Capital. You will need to work with a development finance broker to get access to these lenders, and they will also be able to guide you towards the most suitable providers for your needs.

Many of the firms who operate within the specific niche of development finance tend to be bespoke lenders. This means that most do not advertise or make public their deals and terms. And sometimes, an introduction from a trusted broker is needed even to just get your foot in the door.

The brokers we work with are specialists in helping clients secure development finance for all sorts of projects. Many will have existing contacts and relationships with niche and private lenders.

Examples of interest rates

Development finance rates can vary wildly depending on lots of different variables relating to your circumstances and specific property plans. But to give you an idea, at the time of writing (September 2023), typical rates can range from 6% to 16%.

That’s obviously quite a wide margin and the lender you deal with can make a huge difference to the overall cost of financing your project. This is why it’s well worth speaking to a lender that will be most accommodating to your plans. And the best way to find the most competitive rates is by using the services of a specialist broker.

Using mezzanine finance to fund a development

Although not likely to cover all your financing needs, mezzanine finance can be a useful addition when used in conjunction with other funds as a second charge loan. It can bridge the gap between your capital and funds provided by a lender.

So, as an example your primary lender may only be able to provide development finance equivalent to, say 60% of the overall funding required. If you can only provide a further 20% then you have a further 20% gap. This is where a mezzanine finance arrangement can be useful, plugging the gap in your finances so you can complete on a project, which may otherwise have not been possible.

Alternative options to consider

After putting some initial plans together and discussing them with an expert broker, it may be the case that there are other ways of financing your development that may be more suitable.

A few examples of alternative ways to finance your project include:

Joint venture

If you’ve been rejected or were unable to come up with supporting funds for a deposit, it may be worth exploring a joint venture with an experienced developer. This involves pooling together resources and knowledge to secure finance and can be particularly useful for first-time developers. However, this can sometimes lead to higher rates and profit-sharing percentages of around 50%.

Commercial loans

It can be possible to use a business loan to buy the land or site provided you can afford the monthly repayments and the construction costs for the rest of the development.

Equity release

This can be a good option if you already own an existing residential or commercial property. You could explore refinancing them in order to release equity and help fund a new project.

Bridging loans

These tend to be much smaller in size and funds are paid in a lump sum rather than in stages. But, it’s another type of short-term, interest-only finance that could play a useful role for some developers. Sometimes it can be possible to use both a bridging loan and development finance in tandem.

 

Speak with a development finance specialist

Financing both large and small property developments can be complex projects to undertake. The size of the figures involved also means that small differences can make a big impact to your overall costs and plans.

The best way to get set up with the most competitive development finance arrangement for your specific project and goals is to get advice from a specialist broker. Our free, broker-matching service means that we can introduce you to one that suits your needs.

Just call 0808 189 2301 or make an enquiry. We’ll arrange a free, no obligation chat between you and an experienced development finance broker today.

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FAQs

Not always. Most development finance lenders are not regulated by the FCA (Financial Conduct Authority). But this isn’t necessarily a bad thing. This is why there can be such flexibility in the types of development finance available. Yet, it’s also why you should navigate this market with the guidance of an expert broker.

This can be possible to arrange. It does add some more complexity to the transaction and will likely limit your lending options. Largely because it will involve more research and due diligence for lenders and the exact overseas location can also make a big difference.

Different rules and limits may apply but an experienced broker will be able to show you what your development finance options are for overseas buildings or projects.

It is, but not every lender will be willing to finance development projects across the UK. So, it can make a difference whether you’re planning a project for England, Wales, Scotland, or Northern Ireland. Your location is another reason why it’s important that you deal with a suitable lender for your specific development plans.

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About the author

Pete, an expert in all things mortgages, cut his teeth right in the middle of the credit crunch. With plenty of people needing help and few mortgage providers lending, Pete found great success in going the extra mile to find mortgages for people whom many others considered lost causes. The experience he gained, coupled with his love of helping people reach their goals, led him to establish Online Mortgage Advisor, with one clear vision – to help as many customers as possible get the right advice, regardless of need or background.

Pete’s presence in the industry as the ‘go-to’ for specialist finance continues to grow, and he is regularly cited in and writes for both local and national press, as well as trade publications, with a regular column in Mortgage Introducer and being the exclusive mortgage expert for LOVEMoney. Pete also writes for Online Mortgage Advisor of course!

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Pete Mugleston

Mortgage Advisor, MD

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