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Nov 134 min read

Property Development Finance: How It Works

Development finance is a specialised form of funding used in property development projects, which encompasses everything from small residential builds to large commercial real estate projects. It provides the capital required to purchase land, cover construction costs, and sometimes even manage costs post-completion until the property is sold or refinanced. This type of finance is typically short-term, ranging from 6 months to 3 years, designed to support the various stages of a development project.



Here’s a breakdown of how it works and who it benefits:

 

How Development Finance Works

 

Development finance works by offering funding through a combination of initial land purchase loans and staged release of funds, based on the progress of the development project. Here’s a typical process:

 

  1. Initial Assessment: Lenders assess the project based on the property’s expected value post-completion (known as the Gross Development Value, or GDV), the experience of the developer, and the cost projections.

  2. Loan Structure: The loan is structured in stages, with initial funds covering the land acquisition (up to a percentage of the land’s purchase price) and subsequent tranches released at various project milestones, such as site preparation, foundation completion, and superstructure development.

  3. Interest Rates: Interest is often rolled up (not paid monthly but accrued) to keep cash flow free during development and is repaid once the project is completed and sold or refinanced.

  4. Exit Strategy: A clear exit strategy is crucial, often involving either the sale of the property to pay off the loan or refinancing through a long-term mortgage.

 

Who Benefits from Development Finance?

 

Development finance is essential for a range of businesses in the property sector, primarily:

 

  • Property Developers: Whether large-scale real estate firms or small property developers, these businesses rely on development finance to fund the purchase, construction, and marketing of new projects.

  • Construction Companies: Companies that handle construction or refurbishments, especially those looking to work on larger or more ambitious projects, often use this type of finance to bridge the gap between initial costs and eventual revenue.

  • Investors and Entrepreneurs: Real estate investors and entrepreneurs looking to enter the market use development finance to access high-value projects without needing full capital upfront.

 

Challenges Development Finance Can Help Solve

 

  1. Upfront Capital Requirements: Property development is capital-intensive, and development finance reduces the need for businesses to secure full funding upfront, easing cash flow constraints and allowing smaller players to take on bigger projects.

  2. Project Scaling and Expansion: Development finance helps developers scale their operations, taking on multiple or larger projects without having to wait until each one completes and generates revenue before starting the next.

  3. Risk Management: Development finance enables developers to share the risk with lenders. Many lenders have in-house experts who assess the project viability, providing an additional layer of validation and risk assessment.

  4. Cash Flow Management: With interest often capitalized until the end of the loan term, businesses can allocate resources directly toward development activities without worrying about immediate monthly repayments.

  5. Complex Project Costs: Large developments often face unplanned costs due to regulatory, environmental, or technical challenges. Development finance can help absorb these costs, especially through structured funding tranches that allow flexibility for adjustments.

  6. Expedited Project Timelines: Without the burden of waiting for capital accumulation or traditional mortgage financing (which can be slow for developments), developers can complete projects faster, addressing market demands and increasing revenue potential.

 

Types of Development Finance Products

 

  1. Senior Debt: This is the primary loan provided against the development project and is typically the least expensive form of finance, with the highest priority in repayment.

  2. Mezzanine Finance: A secondary layer of funding that fills the gap between senior debt and the developer’s equity, often used when the project requires additional capital that senior debt doesn’t cover.

  3. Equity Funding: In some cases, lenders may take an equity stake in the project, sharing both the risks and returns of the development.

  4. Joint Venture Financing: For developers who may lack the experience or resources to take on large projects independently, joint ventures allow them to partner with more established developers or investors.

 

In essence, development finance enables property developers and real estate businesses to undertake projects with minimised capital risk, access to larger projects, and efficient management of cash flow and resources. This financing form is instrumental in bridging the gap between project initiation and revenue generation, creating a viable path for growth in the property sector.

 

Enquiries

 

For further information, please contact info@langdoncap.com 

 

About the author

 

Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of debt, equity, M&A and derivatives transactions with global corporates, private equity funds and financial sponsor groups.

 

About Langdon Capital

 

Langdon Capital assists businesses, property developers and property investors in securing debt and equity financing, ranging from £26,000 to £200 million, from the private capital markets. With a panel of over 120 lenders and institutional investors, Langdon Capital helps clients access a comprehensive suite of private capital solutions across real estate, corporate and commercial finance. Real estate financing includes equity, bridging loans, development finance, commercial mortgages and buy-to-let (BTL) mortgages. Corporate and commercial finance solutions encompass invoice finance, asset finance, asset-backed lending, merchant cash advances (MCA), secured and unsecured business loans, revolving credit facilities (RCFs), trade finance, working capital solutions, acquisition finance, structured finance and project finance.

 

 

 

This is not financial advice or any offer, invitation or inducement to sell or provide financial products or services or to engage in any form of investment activity.

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