What is Property Development Financing?
Property development financing is a type of business loan that is secured against a real estate property, be it a building or land. Although it sounds just like a traditional mortgage, property development loans are generally short-term based and are only used for the purpose of building construction or the conversion of the property. When the construction process is over, the builder usually sells the property to another party or it is refinanced by a longer-term development loan with lower interest rates.
Usually, a lending institution approves a specific percentage of the real estate purchase value depending upon the relevant property development plans. If there are no plans yet, the lender might offer another product to purchase the property and to continue with building the project. The risk is very high in property development financing during the construction, as it can be very difficult to sell the secured collateral when it is only half-way done. That is why the interest rates charged on this type of business loan are usually much higher.
Property Development Financing Costs
The costs associated with property development loans can vary greatly from lender to lender. As the risk assessment is done by the lending institution, they are in charge when it comes to determining the interest rate based on perceived risk factors. To evaluate the risk, the lending party considers the location of the building, the borrower’s financial history and experience in similar projects, the loan size, and repayment terms. The lender would then fix an interest rate on the property development loan which can range anywhere from 5% to 16.2% per annum.
Apart from the interest rates, the lending institution can also charge a fee for the arrangement of the property development loan which is around 1% to 2% of the total capital. The lender can also charge a fee for redemption, which is again 1% to 2% of the principal amount. There is also the broker fee to think about too. If the borrower is using a broker to secure the loan then the broker fee can be around 1% to 1.5% of the capital amount.
Property Development Loan Amount
The amount of funding the borrower can get usually depends upon the value of the collateral, the risk factors, as well as the gross development value. The lending institution releases the funds at regular intervals and in stages in order to manage the loan as well as help to protect itself from any losses. The stage payment can be released either every month or at specific benchmarks set by the builder. Generally, most lenders release around 60% to 70% of the property value as it is on day one during the first stage. However, some lending institutions will release the full amount for the property’s purchase value depending on other factors.
Another key thing to note in property development loans is that the borrower needs to communicate regularly with the lender and arrange for site visits as necessary to ensure the smooth release of stage payments. The lender could also appoint a monitoring surveyor to ensure proper release of stage payments as well as to check that the project is right on track as proposed in the plan. The monitoring surveyor can also check the quality of the works done as well as analyze the value of the property at regular intervals.
Risk Assessment and Repayment
Every lending party has its own strategy when it comes to assessing risk before approving a property development loan. Normally, the lenders will require the borrower to provide personal details such as name, date of birth, and address of communication. They would also need details of the company, details of the planning permissions, revisions, and future applications, as well as the expected timeline to complete the project. In some cases, the borrower is also required to submit the detailed costing which the lender can then evaluate and use as a point of reference to release the funds as applicable.
The repayment of the loan amount can be done monthly, quarterly, annually or in full at the end of the project as agreed by both the lender and the borrower. The monthly interest is added to the loan amount so the borrower is not required to pay anything every month. This is because development projects usually have a very poor cash flow during the construction period, and most of the income comes after the completion of the project.
A commonly cited drawback of property development financing is that lenders require too much information to assess the risk in order to approve a loan. Although this can be facilitated by a well-planned project proposal, some of the information might have to be provided individually. Regardless, this type of business financing can be a boon to property developers and can create opportunities for better profits by allowing them to take on bigger projects. Property development financing also allows a builder to work on multiple projects at the same time by helping to ease their financial burdens.