What is Development Finance?

As the bridging world morphed into development finance, it was inevitable there would be lessons to be learned, and that greater sophistication would follow.

So what is Development Finance? Well, Development loans and Development finance loans are both bridging loans for property development, however one is more complex than the other.

The first lesson learned very quickly, was that development finance and property bridging loans have no similarity except both are secured on the property. Whereas bridging loans for property development are mainly non-status and rely almost entirely on the asset, with development finance the promoter’s experience is paramount. Planning, construction and sales risk all need to be measured and managed with regards to development finance.

Also, experience can be measured in many ways. Is a well-trained bricklaying sub-contractor an experienced developer, for example? Clearly not, but many construction operatives see residential property development as much more profitable and physically less arduous than laying bricks or installing the utilities. And, everyone has to start somewhere. Giving a would-be developer a first break is not a bad thing, but it must be approached with the appropriate level of caution and the bridge lender must know the questions to ask.

Whereas bridging relies almost totally on the valuation, development finance also looks at the human side, the cost of construction, planning and the procurement method. Will the construction be delivered by an established contractor under a JCT contract or is the property developer also acting as the builder and employing sub-contractors? Bridging lenders can accept either but clearly the latter has a greater element of risk with cost overruns and delays falling on the property developer’s shoulders without, recourse to a third-party.

Small projects are notorious for exceeding budget. Occasionally this can be funded by the developer but more often than not, this is not possible and if the project is not to fail, the bridging lender has no choice but to increase the facility. The standard 5% or 10% construction cost contingency may not be sufficient and so experienced bridging lenders know to allow for a “silent contingency” which they can utilise if the developer’s calculations are overly optimistic.

Risk and reward must be in parallel and whereas the High Street lenders, that charge the lowest interest rates, consider 50% of Gross Development Value (“GDV”) a suitable maximum, often this is inadequate and specialist bridge lenders will provide 60% or perhaps 65% of GDV, equivalent to 75% or 80% of total development cost.

Sometimes even 65% of GDV is not sufficient and greater gearing can be provided for larger development finance projects, say where the loan is in excess of £10m, either by stretched senior debt or adding a mezzanine piece. This enables developers to undertake a greater number of projects within their capital resources.

Alternative Bridging is now offering a similar facility for smaller schemes with GDV between £750,000 and £4M where they are providing 75% of GDV, equivalent to 90% of development cost. It is an efficient way of financing and avoids mezzanine and equity finance with two lenders and duplication of valuers, solicitors and monitoring surveyors, and offers one point of contact. While it is not rocket science, I would not advise any bridge lender new to development finance to travel this route.

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