Three types of development finance
The first thing to know about property development financing is that there is no such thing as a single model of financing for the entire industry.
There is, in fact, a vast array of different types and models and products of loan finance that exist to cater to the wide range of different types of developments and developers.
To work out which type of financing is most applicable to your potential development, let’s break down the three main types in the UK market:
1) Land Purchase and 100% Build Cost Loan
Development finance is one of the most common types of loan provided by alternative lenders. See lending criteria examples.
Upon successfully applying to receive development finance from a private lender, you could be eligible to receive capital equivalent to 60% of the land purchase cost and even up to 100% of the total build cost of the project.
This money would not land in your account all at once but would be drawn down in stages, requiring the sign-off of a site surveyor at each stage of the build.
2) Bridging Loan
These loans are an instrumental part of major property developments.
Unlike the loans made to developers to secure the land and building and labour costs of property development, a bridging loan is a short-term injection of cash into a project at a critical time.
The loan literally creates a bridge of funding between the expected finish of a build and the sale of a project that allows a developer to repay their original loan.
This bridging funding can cover unexpected delays in the building timetable, or cover the length of time it takes to eventually sell the property.
Some key features of the bridging loan are:
- The loan can carry up to 75% of the property value
- They can have fixed or variable interest rates
- Interest can be paid monthly or at the conclusion of the loan
3) Mezzanine Loan
This represents one of the most complex types of property development loan, but also one of the most important.
Mezzanine loans (sometimes called Mezzanine debt) is usually quite an expensive form of fundraising as it presents a relatively greater risk to the lender.
This is a form of additional financing for a developer who is already subject to a mortgage with a bank and usually carries interest rates of between 10% and 30%.
It can be used to cover:
- Unexpected overheads
- Expanded development
- Additional costs due to changes in planning permission
- Costs arising due to delays
The major benefits of mezzanine funding are:
- Immediate access to necessary cash
- It is often listed as equity (rather than debt) on a company balance sheet, meaning greater access to future financing