As a Property Developer, how do you make your equity work harder?

Raising a hefty depositThe net difference between the acquisition price of the property and the value of the Mortgage. It can be expressed as a monetary value, but more often as a percentage figure; e.g I can get 65% LTV Mortgage, therefore my deposit is 35%. is often a thorn in the side for developersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project., whose equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. provisions may not stack up against their ambitious development plans.  With different types of lenderA company or person that lends money to another. requiring varying depositThe net difference between the acquisition price of the property and the value of the Mortgage. It can be expressed as a monetary value, but more often as a percentage figure; e.g I can get 65% LTV Mortgage, therefore my deposit is 35%. percentages, and even the same lenderA company or person that lends money to another. looking for different depositThe net difference between the acquisition price of the property and the value of the Mortgage. It can be expressed as a monetary value, but more often as a percentage figure; e.g I can get 65% LTV Mortgage, therefore my deposit is 35%. amounts from site to site, it’s a delicate balancing act that many developersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. simply don’t have the time or patience to juggle properly.

 

Taking a broader view

The tendency when it comes to development financeSpecialist funding, specifically used to fund a Development Project. Lenders predominately use a combination of LTC and LTGDV to assess how much they are willing to lend. Other factors also come into consideration; Property Type, Location, Development Experience, Profit Forecast, etc. A lender will determine the total Gross Loan they are willing to advance, and then deduct Lender Professional Fees, Lender Interest, Lender Arrangement Fees, and 100% of the Build Costs. The Residual Loan is then available to draw against the Land, so is often referred to as the Land Loan., is to default to tried and tested senior lendersA company or person that lends money to another., but the depositThe net difference between the acquisition price of the property and the value of the Mortgage. It can be expressed as a monetary value, but more often as a percentage figure; e.g I can get 65% LTV Mortgage, therefore my deposit is 35%. requirements vary hugely from 10% to 20% of total costs (including land, build, finance and professional feesThe fees charged by the Professional Services that accompany a property transaction; e.g. Lawyers, Surveyors, Quantity Surveyors.).  On a scheme with costs of £6m, the required depositThe net difference between the acquisition price of the property and the value of the Mortgage. It can be expressed as a monetary value, but more often as a percentage figure; e.g I can get 65% LTV Mortgage, therefore my deposit is 35%. could therefore be anything from £600K to £1.2m; a huge difference and potentially a make-or-break variance.  If the developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. only has a relationship in place with a lenderA company or person that lends money to another. at the higher end of the scale, this extra £600k depositThe net difference between the acquisition price of the property and the value of the Mortgage. It can be expressed as a monetary value, but more often as a percentage figure; e.g I can get 65% LTV Mortgage, therefore my deposit is 35%. could mean they have to pass on a future opportunity, creating a significant opportunity cost.

 

‘EquityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. is always more expensive than debt. Whether you’re talking in real, financial termsThe period of time agreed between Lender and Borrower, at the end of which the Loan should be repaid or an extension negotiated. Also known as Loan Term., or the opportunity cost of tying up more equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. in a project than is needed.’

 

It’s unlikely that using one source of development financeSpecialist funding, specifically used to fund a Development Project. Lenders predominately use a combination of LTC and LTGDV to assess how much they are willing to lend. Other factors also come into consideration; Property Type, Location, Development Experience, Profit Forecast, etc. A lender will determine the total Gross Loan they are willing to advance, and then deduct Lender Professional Fees, Lender Interest, Lender Arrangement Fees, and 100% of the Build Costs. The Residual Loan is then available to draw against the Land, so is often referred to as the Land Loan. is the most cost-effective route. Most developersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. will introduce other partners to a scheme, perhaps friends, family or people in their wider network.  SMEs, particularly new ones, often struggle with raising equity and securing development financeSpecialist funding, specifically used to fund a Development Project. Lenders predominately use a combination of LTC and LTGDV to assess how much they are willing to lend. Other factors also come into consideration; Property Type, Location, Development Experience, Profit Forecast, etc. A lender will determine the total Gross Loan they are willing to advance, and then deduct Lender Professional Fees, Lender Interest, Lender Arrangement Fees, and 100% of the Build Costs. The Residual Loan is then available to draw against the Land, so is often referred to as the Land Loan..  Similarly, corporates are more likely to work on a joint ventureTypically used in Development Finance when two or more partners collaborate on a project. Normally each party has a different skillset; e.g. one party maybe an experienced Developer / Development Manager and the other may have less practical experience, but have more Equity available to get the project off the ground. A contract will normally be drawn up to recognise each parties contribution, and the profit share / return that they entitled to at the end of the project. basis to help boost their equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity., so following the example above, a developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. may put in £600K of their own money and raise £600K from an additional investor to whom they pay profit shareNormally used by a business to incentivise employees and typically expressed as a percentage. In property transactions it could be the share of profit between equal or unequal partners in a JV scheme. Or, a Developer may offer their team a Profit Share if they perform to time or budget. We most often see it if a Developer is deemed by the Lender not to have the necessary experience for that particular scheme. Rather than not lend, the Lender may suggest that they incentivise the main building contractor via profit share..

 

‘Cheap development debt is almost always a false economy. DevelopersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. need to be smarter. They need to realise their most precious resource is time, shortly followed by their own equity’.

 

To put this into context, let’s say there is a site that has combined land and build costs of £6m. The GDV is £9m and the build termTerm typically used in Development Finance, referring to the period of time within the Loan Term that is allotted to the building of the site. When the land is being purchased the Land Loan will complete, and the Build Loan will be drawn on a Stage Release Payment basis to pay the Contracted Construction Costs. The Build Loan typically draws down within 1 or 2 months of the land acquisition completing, and then after the Build Loan is fully drawn and the works are complete, the remaining Loan Term (often referred to as the Sales Period) allows time for the end units to be sold. It is the Build Term, plus the Sales Period, that will make up the Loan Term of a Development Loan. is 12 months. The exitVitally important for both Bridging Finance and Development Finance. The term refers to how the loan will be redeemed; typically this is Sale of Property, or Re-Finance. Expect the Lender to evaluate the plausibility of either option and amend the terms accordingly. is saleReferring to the sale of a property. We use the term in Development Finance and Bridging Finance to describe the Exit Strategy the Borrower expects to use to repay the Loan. of the units, therefore we take an 18 month loan termThe period of time agreed between Lender and Borrower, at the end of which the Loan should be repaid or an extension negotiated. Also known as Term. so we have 6 months to sell the units.

DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A uses a well-known high-street lenderA collective term used to apply to the mainstream UK Mortgage Banks. Generally good for simple loans up to £ 1m. Above £ 1m there may be better options in the Private Banking or Specialist Lender sectors. Also known as Mainstream Banks / Lenders or Retail Banks / Lenders. to provide their debt. The rate is attractive at circa 5%, but they are required to invest £1.2m of equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. (20% of costs). DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A puts in £600k and their investor puts in £600k. They pay their investor 5% interestRegular payments made by a Borrower to a Lender in return for the money that has been lent to them. and 40% of the profit. LenderA company or person that lends money to another. costs are £400k, taking total costs to £6.4m. Profit is £2.6m, so the investor is due £1.04m (40%). DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A makes pre-tax profit of £1.56m in 18 months. Very good.

On the same scheme, DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. B takes the time to search the entire market and finds a different lenderA company or person that lends money to another.. This lenderA company or person that lends money to another. charges 7.5% for the debt, so a slightly more expensive rate, but they can borrow £600k more. DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. B doesn’t need an investor and doesn’t need to give 40% of their profits away. The cost of the debt is £600k, so total costs of £6.6m. Profit is £2.4m, but there is no profit shareNormally used by a business to incentivise employees and typically expressed as a percentage. In property transactions it could be the share of profit between equal or unequal partners in a JV scheme. Or, a Developer may offer their team a Profit Share if they perform to time or budget. We most often see it if a Developer is deemed by the Lender not to have the necessary experience for that particular scheme. Rather than not lend, the Lender may suggest that they incentivise the main building contractor via profit share.*. DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. B earns £840k (pre-tax) more than DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A in the same period of time. The only difference is DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. B has shopped around for his funding.

 

‘When you’ve spoken to as many developersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. as we have, you start to realise the differences between them. A developer’s network and their ability to find deals and the right personnel to work with them is critical.  But in our opinion the fundamental difference between average developersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. and great ones, is their ability to make debt work for them.’

 

Structuring your debt

The key to stretching your equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. further is to determine the best capital stackA term used to describe the different elements of Debt and Equity, that can make up the totality of a property value. For example; if you take a property that is worth £ 1m. Let's assume there is a First Charge Loan of 50% LTV (£ 500k) and a Second Charge or Mezzanine Loan of 15% LTV (£ 150k). The total debt is therefore £ 650k or 65% of the property value. In this case, the remaining 35% is the owners original Deposit, and is the Equity value in the property. All 3 elements combined equal 100%, and that is the capital stack. for your project; essentially the different layers of finance, which become the building blocks for your funding.  As well as providing you with increased flexibility with your own equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity., and the potential of greater subsequent profits, investors are also able to see where they fall in the hierarchy of cash flows.  This determines the level of risk, and ultimately helps them decide whether the ROI is worth the associated risk.

 

Typically, a capital stackA term used to describe the different elements of Debt and Equity, that can make up the totality of a property value. For example; if you take a property that is worth £ 1m. Let's assume there is a First Charge Loan of 50% LTV (£ 500k) and a Second Charge or Mezzanine Loan of 15% LTV (£ 150k). The total debt is therefore £ 650k or 65% of the property value. In this case, the remaining 35% is the owners original Deposit, and is the Equity value in the property. All 3 elements combined equal 100%, and that is the capital stack. has three tranches, and the higher positions in the stack earn higher returns due to their increased risk.  Those at the bottom of the stack are repaid first, so any losses are incurred from the top down.  How you structure your allocation of equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. and debt should be determined by your investment objectives, so a strategic approach is a must.

 

 

Keeping cash as king

So, how can you utilise the capital stackA term used to describe the different elements of Debt and Equity, that can make up the totality of a property value. For example; if you take a property that is worth £ 1m. Let's assume there is a First Charge Loan of 50% LTV (£ 500k) and a Second Charge or Mezzanine Loan of 15% LTV (£ 150k). The total debt is therefore £ 650k or 65% of the property value. In this case, the remaining 35% is the owners original Deposit, and is the Equity value in the property. All 3 elements combined equal 100%, and that is the capital stack. to stretch your equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. further?  Essentially, it’s about keeping your cash as a last resort.  As well as shopping around for different lendersA company or person that lends money to another., experiment with different loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More structures.  Consider senior, stretched seniorTypically used in Development Finance but also available for Commercial Property, it refers to a class of loans that offer higher LTC and / or LTGDV than a normal standalone Senior Lender. It's like a combination of Senior + Mezzanine, except you would still normally achieve a higher loan with Senior + Mezzanine. A Senior Lender will normally go to 60% or 65% LTDGV, whereas a Stretched Senior Loan may go to 70% LTGDV. On a Senior + Mezzanine loan, you can achieve 75% LTGDV. As you would expect, rates are higher for Stretched Senior than for Senior Only Loans. The term is also used in the Commercial Mortgage market, as Alternative Lenders continue trying to make inroads to the main lenders market share. and mezzanine, which can be combined in many different ways to allow you to minimise the equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. you invest.

 

Taking the time to shop the market and play around with different debts can help you create the optimum capital stackA term used to describe the different elements of Debt and Equity, that can make up the totality of a property value. For example; if you take a property that is worth £ 1m. Let's assume there is a First Charge Loan of 50% LTV (£ 500k) and a Second Charge or Mezzanine Loan of 15% LTV (£ 150k). The total debt is therefore £ 650k or 65% of the property value. In this case, the remaining 35% is the owners original Deposit, and is the Equity value in the property. All 3 elements combined equal 100%, and that is the capital stack., maximising profit and ultimately optimising your equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. deployment.

 

In our next blog, we’ll be looking at three more ways to conserve your cash and make your equityThe difference between the debt and the asset value; the part that the Borrower actually owns. The equity value can increase in value over time, if debt is reduced and / or the property increases in value. The reverse can also happen. See Negative Equity. go further.

 

If you’d like to discuss your capital stackA term used to describe the different elements of Debt and Equity, that can make up the totality of a property value. For example; if you take a property that is worth £ 1m. Let's assume there is a First Charge Loan of 50% LTV (£ 500k) and a Second Charge or Mezzanine Loan of 15% LTV (£ 150k). The total debt is therefore £ 650k or 65% of the property value. In this case, the remaining 35% is the owners original Deposit, and is the Equity value in the property. All 3 elements combined equal 100%, and that is the capital stack., or for more general development financeSpecialist funding, specifically used to fund a Development Project. Lenders predominately use a combination of LTC and LTGDV to assess how much they are willing to lend. Other factors also come into consideration; Property Type, Location, Development Experience, Profit Forecast, etc. A lender will determine the total Gross Loan they are willing to advance, and then deduct Lender Professional Fees, Lender Interest, Lender Arrangement Fees, and 100% of the Build Costs. The Residual Loan is then available to draw against the Land, so is often referred to as the Land Loan. advice, please give us a call on 02078410184 or email info@propertyfinancegroup.com

 

 

*The figures in the worked example are for illustrative purpose only, and not an actual case study.