Residential Development Finance
By Brian Rubins, Executive Chairman
Time To Start Building…
Notwithstanding the cessation of the Stamp Duty holiday, the supply chain problems, labour shortages and ending the furlough scheme, our economy is telling us it is time to get going – to start new housing developments. This will need finance.
For the national housebuilders finance is almost on tap through the major banks and capital markets. Also, they have substantial retained profits to invest in new sites and to finance developments. However, even the very big fish feed off the land owners by the use of options, deferred completions and part-payments. Rarely do smaller developers have these luxuries so let us take a look at what is available for them.
Residential Development Finance
Residential Development Finance (“RDF”) is a wide offering – from finance to purchase sites, funding of development costs including fees and interest to holding finished stock pending sales. It also includes refurbishment, extension and conversion of existing properties. There are limitations on what can be borrowed but there is no shortage of liquidity.
The first port of call is usually one of the High Street banks, but unless the borrower has a strong, existing relationship this is unlikely to be fruitful. It is less expensive than the alternative sources but in recent years far less readily available. This market change has opened up opportunities for challenger banks, alternative lenders and for brokers.
Residential site availability
So what is available? Residential developments include new build on greenfield and brownfield sites, conversion of commercial properties to residential use and more recently the addition of extra floors on existing buildings – roof-top or penthouse schemes. Unlike bridging finance where loans are governed by LTV (Loan to Value) covenants, RDF is geared to LTGDV, Loan to Gross Development Value. This is far more generous because it takes into account the added value which occurs on completion of the construction.
In calculating how much can be applied to the site purchase, the lender will first review the GDV and lend up to 65% against this value. From this they will deduct the cost of carrying out the project including interest and fees, and the remainder is available for the site purchase. Although some lenders are more conservative, 65% of GDV can be achieved which will break back to approximately 80% of total cost. Although most developments of up to 20 units or so can be built in 12 months with a sales period of 6 months, loans can be for up to 24 months where necessary.
Interest rates and fees vary from lender to lender and take into account the size of the loan, the experience of the developer and the level of gearing. For a typical loan up to £5M at 65% of GDV, interest will be between 7% and 10% p.a. and in addition there will be the lender’s arrangement fee of 1% and probably an exit fee also at 1% of the loan payable from sales proceeds. Alternative Bridging Corporation has introduced into its programme reduced interest rates after practical completion and an extended loan term, if needed, to enable sales proceeds to be maximised in an orderly less costly way.
For larger loans, say from £5M upwards, Stretched Senior Debt and Mezzanine Loans have been available for some time whereby 75% of GDV, say 90% of cost, is advanced. However, in recent months this has also become available for loans starting at £2M for experienced developers, those who can evidence at least three similar previous projects. Pricing for these loans will include a larger exit fee to compensate for the higher risk.
But there are important considerations other than the interest rates and fees. In particular the support from the lender’s Asset Management Team, the people who make sure monthly stage payments are released on time to enable suppliers and sub-contractors to be paid. They should also be on hand to help to deal with delays in the programme and increased costs, both prevalent following labour and material shortages. Lenders new to RDF do not necessarily have the resources, experience or capability to take the longer view when problems occur.
Make sure you pick an experienced lender
Further, experienced lenders will guide the developer through the drawdown process which is more complicated than for a bridging loan. The lender will require a valuation as is normal, but unless the scheme is very small, they will probably also appoint a Monitoring Surveyor who will review the project before commencement and carry out the monthly stage payment valuations. The MS will review the requirements of the planning permission, particularly pre-commencement conditions, investigate the contractor’s capability and check if a Homeowners Warranty has been arranged with NHBC or another provider. Be aware, this takes time.
RDF is much more than ground-up residential developments and includes refurbishment and extension of single homes by both developers and owner-occupiers. Again, the formula is to lend against GDV even though Light Refurbishment is, in fact, the extension of a bridging loan. It is limited to non-structural changes and excludes extensions. However, Heavy Refurbishment includes extensions, basement digs, extra floors and internal rearrangement and will be treated as RDF and not a bridging loan.
When lending to an owner-occupier for refurbishment, the loan is Regulated and because of this cannot be for more than 12 months. This demands very careful planning to ensure the construction can be completed within 9 months, leaving 3 months to refinance and repay the development loan. Also, homeowners do not usually have prior experience of residential development and need a strong contractor and professional team to ensure the pitfalls are avoided.
An extension to bridging loans
Residential Development Finance is the natural extension to bridging loans, and a route to additional business and larger loans for brokers to pursue. There is a learning curve but a close association with an experienced lender will help to close the deals.
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