Property development can be a profitable and rewarding business. But whether you’re looking to build new homes or commercial premises from the ground up, renovate an existing property, or buy a property and convert it, there are substantial costs to cover. Unless you have lots of cash handy (which is unlikely when you’re starting out), then you’ll need to use property development finance.
In this article, we’ll take you through some of the different types of property development and investment finance to help you consider which might be best suited to your needs. We’ll also refer to some real-life examples so you can see how others have used property development loans to support their projects.
What is property development finance?
Property development finance refers to funding that is used for residential, mixed-use, and commercial property development projects. It’s a broad term that covers a range of finance options, from mortgages and term loans to bridging and mezzanine finance.
How to finance property development and investment
The type of funding you use will largely depend on what your plans are for the property. Let’s take a closer look at some of the most common options and their main features.
One option is to use bridging finance for property development. Essentially a short-term loan secured against an asset (usually a property already owned or the one being purchased), it can be a good solution if you need to access funds quickly for a short period of time. For example, you may use it in the following scenarios:
- To bridge the gap when you want to buy a new property, but you’re waiting for one of your existing properties to sell
- When you’re buying a property at auction or looking to purchase an in-demand property
- When the property you’re buying isn’t eligible for a mortgage due to its condition. A bridging loan can give you the funds needed to renovate a property and make it habitable; once this is done, a traditional mortgage can be arranged
- To buy land without planning permission in place. Once planning permission is obtained, you might then refinance to another facility such as a property development loan
Bridging loans are a fast and flexible way to get the finance you need, often being secured in a matter of days. However, the downside is that they tend to have higher interest rates, and many come with additional fees, such as arrangement fees, legal fees, and exit fees.
Property development loans
For larger scale projects, such as building houses or commercial premises from scratch, or converting an existing building into new homes, a property development loan is often the best option.
This is because you’re usually able to raise a larger amount than you would with other types of finance such as bridging loans. Unlike bridging finance, a property development loan is often released in stages based on achievement of milestones in the project.
Here at the Development Bank of Wales, we provide short-term loans from £150,000 - £6 million for residential and mixed-use developments, and £250,000 - £5 million for office and industrial, to support small to medium-sized developers in Wales.
One business we’ve helped with property development finance is Dawan Developments. We provided a seven-figure commercial property loan to support its development of a commercial site known as Spider Camp in Sully. The site comprises six light industrial buildings, made up of 42 individual units. These are designed as starter units for growing businesses and start-ups who need smaller commercial spaces.
To give another example, Lewis Homes secured a £3.3 million funding package from us, enabling it to start work on 76 new homes in Tonyrefail. This followed a £4.75 million short-term loan to finance the build of 56 homes, including four social housing and four low cost, at Dôl Werdd, Plasdwr.
Mezzanine finance is often used as top-up funding, filling the gap between a developer’s available deposit and the loan provided by the senior lender (typically a bank).
Mezzanine funding can be unsecured, or it can be secured by way of a second charge over the property or development site. It is subordinate to senior debt, meaning that if the company or development goes under, the mezzanine lender is second in line to be repaid, after the main lender. Because of this, mezzanine finance is viewed as a riskier form of lending and so will usually command higher interest rates than a traditional loan.
On the plus side, many mezzanine loans are interest only, which can help you manage your cash flow, and generally it’s a very flexible type of finance for the borrower. For example, there is often the option to ‘roll up’ the interest so that it’s paid at the end of the loan term, or to part pay / part roll.
Mezzanine finance can be useful when you need to borrow more money than you’re able to raise from the main lender alone, helping you to get the deal over the line. As it reduces the amount of money you need to put in yourself, it can also boost the internal rate of return on your investment and enable you to retain your money for future projects.
To learn more about this form of funding generally, check out our blog post, What is mezzanine finance?
As the name suggests, a buy-to-let mortgage is specifically for people who want to buy a property to rent out to tenants. It’s similar to a standard residential mortgage, but with some key differences.
One difference is that the majority of buy-to-let mortgages are interest only. This means that every month you only pay off the interest charges on your loan and not the actual loan amount, which makes it more affordable in the short term.
However, you’ll need a plan in place to repay the original loan amount in full at the end of the mortgage term – this could be by selling the property, taking out another mortgage, or using savings. It’s important to bear in mind that if house prices fall and your property ends up being worth less than you paid for it, you’ll be responsible for making up any shortfall.
Buy-to-let mortgages are also generally seen as riskier for lenders than ordinary mortgages, as tenants may not pay their rent on time or there may be void periods where the property is unoccupied. As a result, interest rates tend to be higher, and a larger deposit is often required (usually at least 25% of the property’s value). As with a standard residential mortgage, the larger the deposit you put down, the better the rate you’ll be able to get.