Development Finance hacks to stretch your equity further

[4 mins read]

 

There’s a common misconception among property developersAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. that 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. means stumping up a large cash 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%..  This was certainly true when the big banks dominated the lending market, but now a broader range of borrowing options have opened up, so has the scope to 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. work harder.

You’ve heard the expression there’s more than one way to skin a cat? Well, there’s definitely more than one way to secure a debt.  In our last blog, we looked at how to structure 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. to optimise 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..  Here’s four more of the smartest ways to keep hold of your cash and still land the 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. you need.

 

Consider a second chargeA legal charge executed on behalf of a Lender that sits junior to the First Charge. Second Charge Loans are generally more expensive than First Charge Loans, due to them being more risky. In a default scenario the First Charge Lender is redeemed entirely before the Second Charge Lender can state their claim. Also known as a Mezzanine Loan.

It may sound obvious but look to leverage other assetsAn item of property owned by a person or company, that has a value and could be used as Security for a Loan. before you reach for your wallet.  Second chargeA legal charge executed on behalf of a Lender that sits junior to the First Charge. Second Charge Loans are generally more expensive than First Charge Loans, due to them being more risky. In a default scenario the First Charge Lender is redeemed entirely before the Second Charge Lender can state their claim. Also known as a Mezzanine Loan. loansWhen 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 allow you to use 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 commercial propertyAn asset, normally to be held for the long-term and to produce an income, and / or Capital Growth. Examples include; Hospitality (hotels), Retail (shops), Leisure (pubs), Student Accommodation, Medical (GP Surgery), Light Industrial (Shed / Logistics), Heavy Industrial (Manufacturing Plant), HMO (House of Multiple Occupancy; e.g. Bedsit), Office, Care Home / Retirement and Educational (University / Private School). or piece of land as securityAn Asset used as Collateral for a Loan. for another 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, despite having an existing mortgageAn agreement that allows a Borrower to borrow money from a Lender, by using a property as security for the Loan granted. The Lender will take a charge over the property to secure their Loan..  We recently helped a developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. client that had a BTL portfolioWhen a person or company holds multiple BTL properties. The widely accepted Industry definition is 4 or more BTL Properties to be considered a BTL Portfolio, or to be a Professional Landlord. If you hold 4 or more BTL Properties the lending rules that need to be applied are different to those with less than 4. The rules on this can be found here. who was looking to access 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. for a 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%., without losing the favourable rates he had secured on his mortgagesAn agreement that allows a Borrower to borrow money from a Lender, by using a property as security for the Loan granted. The Lender will take a charge over the property to secure their Loan. prior to the 2008Used to refer to the 2008 Financial Crisis (or Crash), which is recognised as the worst financial crisis since the 1930's depression. With its origins in the US sub-prime mortgage market in 2007, it counted established industry titans such as Lehman Brothers and Bear Stearns among its casualties, leading to government bailouts of banks around the world and protracted economic downturn. crash.

There was an opportunity cost to the client of not being able to access his 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., but there was also a real financial cost in releasing the money.  We were able to arrange a bespoke revolving credit facilityA loan that enables the Borrower to increase or decrease the Loan quantum, within Lender agreed parameters, during the course of the Loan Term. In property lending we usually arrange these facilities for Property Developers or Bridging or Development Lenders, so that they can add additional properties or qualifying loans as collateral. secured on a second chargeA legal charge executed on behalf of a Lender that sits junior to the First Charge. Second Charge Loans are generally more expensive than First Charge Loans, due to them being more risky. In a default scenario the First Charge Lender is redeemed entirely before the Second Charge Lender can state their claim. Also known as a Mezzanine Loan. basis across 11 properties. He then used 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. for a 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%., meaning he wasn’t required to use any cash for his 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%., and in fact, it was a 100% cashless deal.

 

Leverage the planning process

If you buy or option a site without planning permissionOfficial permission from a local authority to build or alter a building., you will add value during the planning process known as ‘sweat equity’.  This type of investment measures time and effort put into a project.  Securing planning permissionOfficial permission from a local authority to build or alter a building. is time consuming and arduous work, so good lendersA company or person that lends money to another. will take this into account when assessing a loan applicationWhen we formally apply to a Lender for a Loan. Depending on the Lender, this may involve Credit Referencing, so we will always seek your express permission before committing to do this. Beforehand you should have received Heads of Terms or a KFI that would explain the Loan you are applying for. and lending opportunity.

Every lenderA company or person that lends money to another. will take a different view on the value of sweat equityTypically used in Development Finance to describe the value added to a site before Development commences, typically through Planning Gain. The value add has been greater than the spend. As an example; if you buy a site at £ 2m, and spend £ 500k on planning, which when the Planning Permission is granted the site is worth £ 3.5m, we would say that the Sweat Equity value was £ 1m. Lenders approach to Sweat Equity varies widely, with some not recognising it all. It can be a valuable tool for Developers who are looking to maximise their Equity., so as always, our advice is to shop around and find one that truly sees the value you can add as an experienced property developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project..

We recently helped a client who purchased a mixed-use site for £1.7m, with outline planning for a knockdown and rebuild. He needed help to fund the £510,000 plus costs required to purchaseThe act of buying something from another person, or in property terms, buying a property from another person. the site but knowing the value would increase through the planning process, he wanted to avoid an investor contributing a small amount 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. but taking a 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. on the full scheme. We arranged a bridging 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 to acquire the site and then raised enough debt in the development loanSee Development Finance. phase to repay the investor when we replaced the bridging 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 with the development loanSee Development Finance., before the project was finished. Read the Case Study here. Through adopting this approach, our client was able to retain an additional £1m in profit.

 

Use external 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. wisely

If you need to raise money from other investors to make a scheme happen, don’t be too generous with your 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.. Remember you’re the linchpin of the project and without you the development wouldn’t be on the table, so be mindful when assessing your finance options. If you buy during the pre-planning phase, it’s also possible to repay 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. when you raise the 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. for the build stage, so you’ll only need to pay your investor a percentage of the profit on the uplift during the planning process, not on the full profits of the scheme.

To put some numbers to this, here’s a worked example. DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A borrows £5.5m from a high-street bank at 5% interestRegular payments made by a Borrower to a Lender in return for the money that has been lent to them., based on 55% LTGDVTypically used in Development Finance as a ratio, to measure the Loan granted in relation to the overall end value of a development project. A Lender may offer 60% LTGDV and 80% LTC, and it is the lower of these two ratios that will determine the final loan size advanced. The Loan advance will include an allowance for Lender interest and fees as these are normally rolled up (See Rolled-Up Interest). on a Gross Development Value (GDV) of £10m. The total costs of the scheme are £7.5m (pre-finance), leaving the developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. with £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. to find. The developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. has £1m, so needs to secure the rest from an investor. After the finance costs are added, he makes £2m in profit, but has to repay the investor his original £1m, and share half the profits from the remaining £2m. This leaves £1m of profit for DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A.

DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. B shops around and finds a lenderA company or person that lends money to another. who offers a slightly higher rate of 7.5%, but a LTGVD of 65%.  He therefore needs only £1m 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., which he already has, meaning there is no need to find an investor or offer a 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., making his profit £1.75m (after finance costs), rather than the £1m earned by DeveloperAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. A.

 

Request a deferred land payment

One of the lesser known tricks of the trade, but a useful one to have in your development arsenal, is a deferred land payment.  This is where a developerAn individual or entity that buys and improves property, or builds entirely new properties, that are typically sold at completion of the project. wishes to buy a piece of land, and the land owner agrees to receive part of the payment once the properties have been built and sold (potentially at a premium for the benefit). The lenderA company or person that lends money to another. providing the 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. has first charge over the land and lends all of the build costs, plus a portion of the land acquisition costs.

The buyer gives the lenderA company or person that lends money to another. securityAn Asset used as Collateral for a Loan. over a site that is worth more than they have paid for it (so far), thus de-risking the lenderA company or person that lends money to another. and allowing the buyer to access greater value projects with smaller depositsThe 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%.. It is common for the landowner to request a second charge behind the lenderA company or person that lends money to another., and the landowner can only be repaid after the lenderA company or person that lends money to another., as per the loan agreementAlso known as 'Formal Offer', this is when a Lender has underwritten the loan and the loan has been approved by its credit committee. There will be conditions (Conditions Precedent) that will need to be met before the loan can be drawn, but most of the hard work is done..

Not every lenderA company or person that lends money to another. will agree to this type of lend, and if they do, every lenderA company or person that lends money to another. will take a slightly different approach, so this is a case where you will need to seek expert advice from a brokerAn agent that negotiates situations for others. For us, this definition goes much further. A good Broker should be indispensable and add considerable value to you. I've not met any Property Professionals who do not recognise the importance of Brokers. Think of a broker as an extension of your business; like another employee but they are variable cost not a fixed cost, the FD you can't afford to hire..

In practice, it could look something like this. A client agrees to buy a piece of land for £800,000. The land owner agrees to take payment of £500,000 now and £300,000 when the properties are built and sold. The lenderA company or person that lends money to another. is happy to lend £300,000 on day one against the land, which would normally mean the borrowerThe person, persons, or commercial entity applying for the Loan from the Lender. would have to find a 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%. of £500,000 plus land transaction costsUsed in Property Development to cover the costs associated with making the Land Purchase. Transaction Costs are a legitimate cost for providers of Development Finance to consider the Borrowers overall Real Equity contribution to the scheme. SDLT and Legal Fees are two such examples.. However, if the lenderA company or person that lends money to another. is happy to use the deferred land payment, then the borrowerThe person, persons, or commercial entity applying for the Loan from the Lender. only needs to pay £200,000 plus costs, meaning a huge reduction in the required 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, what are our key property finance hacks when it comes to funding your next development? Weigh-up whether your existing assetsAn item of property owned by a person or company, that has a value and could be used as Security for a Loan. could help secure a second chargeA legal charge executed on behalf of a Lender that sits junior to the First Charge. Second Charge Loans are generally more expensive than First Charge Loans, due to them being more risky. In a default scenario the First Charge Lender is redeemed entirely before the Second Charge Lender can state their claim. Also known as a Mezzanine Loan., know your worth when it comes to sweat equityTypically used in Development Finance to describe the value added to a site before Development commences, typically through Planning Gain. The value add has been greater than the spend. As an example; if you buy a site at £ 2m, and spend £ 500k on planning, which when the Planning Permission is granted the site is worth £ 3.5m, we would say that the Sweat Equity value was £ 1m. Lenders approach to Sweat Equity varies widely, with some not recognising it all. It can be a valuable tool for Developers who are looking to maximise their Equity., shop around to ensure 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. is a last resort, and don’t forget a deferred land payment could well be an option, and a good one at that.

 

For more advice on securing the right finance for your next development, please give us a call on 0207 846 0184 or email info@propertyfinancegroup.com

 

 

October 2019