Development Finance for First-Time Developers

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Development Finance for First-Time Developers

Development Finance for First-Time Developers

Scott West explains how development finance works for first time developers.

What are the requirements for obtaining development finance for first time developers in the UK?

The main requirement for planning development finance is for applicants to understand the process of building a property from the ground up. It’s often referred to as ‘ground-up development’.

While there may be some variations, it’s crucial for clients to comprehend what’s involved in constructing a property from scratch. It’s more than just laying bricks; it encompasses foundations, infrastructure, utilities, and many other elements. A broad understanding of this process is invaluable.

Typically, developers do have some background in the field. They might have worked on construction sites, have family members in the business, or have experience as architects or designers working with developers.

In terms of financial requirements, you need a well-structured plan and a clear understanding of costs. A builder should provide a detailed schedule of works and cost estimates. Also, having a contingency fund of at least 10-15% of the total project cost is very important, to cover any potential errors or cost fluctuations.

Can you explain the different types of development loans available for first time developers in the UK?

Residential and commercial development finance are two distinct categories. Residential development is for building houses for residential use, while commercial development includes offices, hotels, warehousing, and other non-residential properties.

The application processes for both are similar, but lenders, interest rates, and costs will differ. Another factor to consider is whether you’re starting from scratch or if there’s an existing structure to be refurbished or demolished. This can affect the project’s overall costs.

What are the key factors to consider when comparing different development finance options for first-time developers?

The important thing is to understand your project and make sure it’s a manageable size that aligns with your experience level. Overly ambitious projects can lead to higher costs and make it difficult to secure a lender.

Start small, gain experience, and then gradually take on more substantial projects, because that will make lenders much more likely to work with you in the future.

How does the loan application and approval process work for first time developers seeking development finance in the UK.

It’s similar to a standard mortgage. We still have an underwriting process, a valuation process and an offer process. First and foremost it’s about correlating information provided by the client for me to submit the application.

That requires the planning permission documents, drawings for the building, architects’ images, builder details and costings. Quite a lot of information is required. Once that’s packaged for the lender it’s similar to a normal mortgage. We’ll submit all that along with an explanation of the client’s experience.

That’s underwritten, a valuer will attend the site to give an estimate on the Gross Development Value (GDV), which is how much the property will be worth once complete. Lenders will use that GDV figure as a cap for the lending amount and to understand how the exit works.

The exit is a vital part of the whole process: the lender needs to understand how you plan to repay the finance. It could be a sale, it could be refinancing – but these need to be viable. So the lenders will look at how much they’re going to lend you, the build costs and the GDV. Plus, you need to make sure there’s enough profit in there to make it viable for you.

What are the potential risks of taking out development finance as a first time developer? How can they be mitigated?

There are always risks, and how you can mitigate them is having a sufficient contingency pot in place. The risks are largely around overspending. People tend to get excited halfway through and decide to upgrade the bathroom and other parts of the project.

Their friends show them something on Instagram and they decide to change their plans. But that’s risky, so find a budget, find a plan, stick to it and don’t change. That’s a really big part of it.

You’ll know from watching Grand Designs that people can increase their budgets exponentially – that’s fine if you plan to live in the property and you can afford to do so. But we’re talking here about developing for investment purposes. You’re not going to live in it, so don’t get too excited about the fixtures and fittings.

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What should first time developers look for in a mortgage advisor when seeking development finance?

Find someone who you can discuss your plans openly with. This is quite an in-depth process, so you need to find an advisor that you can work with closely, who you won’t dread a phone call from.

The test I tend to use is, could I go for beer with this person? Could I spend time with them and not want to strangle them or get bored of the conversation? If that generally applies you’re probably in the right place.

Secondly, check whether they are asking enough questions? Are they interested? Do they seem knowledgeable enough? If you come to them with a project, they thank you and say they’ll get started without asking you any questions – they’re probably not invested enough to work with.

What are some common mistakes that First Time Developers make when applying for or managing development finance? How can they be avoided?

People tend to overcomplicate the process. At some point you’re going to speak to the underwriter, who just wants to get an idea of who you are, your interests for the development and your plans for the future.

You might have future projects in mind: maybe you’re doing a couple of projects now, or you have plans to do many more and get bigger and bolder as you go.

A lot of clients overthink that process and start saying things they think the underwriter wants to hear, and not the truth. You can get caught up in a web of tall tales – and that just confuses the underwriter. We’ve been giving them a narrative about your experience and who you are, and then on the phone call with you it doesn’t tie up.

So just be honest and truthful with those conversations. It makes things much simpler.

Do you have any real world examples of successful first time developers who have obtained development finance in the UK?

We’ve got a lot of repeat developers. We had a first time developer a couple of years ago who had a site at the end of his garden. He split the titles and developed two
houses.

He’d been a builder for most of his life so he had lots of relevant experience, and the lenders took him seriously. His numbers seemed logical and he put together a very good business plan from the start – it was a very straightforward project.

We got him a traditional lender with good rates and the exit was a refinance. He kept them as two Buy to Lets. He was a showcase example of how it works, really.

How has the Covid-19 pandemic affected the availability of development finance for first time developers? What steps can they take to secure funding?

Covid didn’t really impact the availability of the finance, but it did impact the availability of builders and the cost of goods. The cost of timber went up dramatically which bumped everybody’s costs up.

If you were partway through a development, the costs really jumped up a lot and it made the products unviable or eradicated any profit. It also meant people applying for new finance had much higher build quotes than they expected, which made some projects non-starters.

The GDV values weren’t really changing but the build costs were, which reduced profit margins. Lenders won’t lend on a project where there’s no profit. The impact is dropping down now. Timber costs came down, other costs are coming down and labour is now mostly back to where it was. With no restrictions in place now, that really helped things along.
[podcast recorded in October 2023]

What advice would you give to first time developers who are considering using development finance to fund their projects?

Try to be very practical and pragmatic with the process. It can be hard, but remove your emotional involvement. As I mentioned earlier, people get too caught up in making things fancy. Be objective and keep it as an investment project that fits your initial brief.

Secondly, remember that development finance, cost-wise, is different to your traditional mortgage. When you see rates of 7%, 8% or 9% per year, don’t be worried about the figures. They were built into your costs and around your profit margins.

People tend to see that and think it’s expensive compared to mortgages which historically would have been 3% or 4%, although right now we’re seeing them at 5% and 6%. People get worried when they compare them, but they are very different finance options, so try to be pragmatic about that.