How to finance property development
If you’re a property developer, investor, or landlord, there’s a range of finance available to help you kick-start your next project. But even for experienced developers, the alternative lending market can feel large and complex — on this page we’ll run through some of the things to think about, so you can make the right property development finance choices.
Commercial mortgages can be used to purchase commercial property like shops, offices and warehouses — almost anything that isn’t private residential property. Broadly speaking, they work the same way as private mortgages, helping you spread the cost of a large purchase over time (generally a number of years).
The most straightforward commercial mortgages are taken out by existing businesses who want to buy their own premises, where the business already operates. A typical example could be a dentist who wants to buy the building where she practices — instead of paying large amounts of rent, she would prefer to own the property, but can’t afford to pay for it outright.
If you don’t want to contribute cash yourself, it’s sometimes possible to secure 100% of the finance using additional security — but you’ll need to have favourable circumstances, like a solid trading record and a history of operating from the same premises. While it's easier to secure a commercial mortgage as an existing business, it's possible to get one for a startup too — although it’s more challenging because there's more risk for the lender.
Commercial mortgages vs. buy-to-let mortgages
Another situation where a commercial mortgage might be suitable is when a landlord with a large property portfolio wants to buy more properties — by combining multiple properties into one mortgage, it’s possible to cut arrangement fees and take advantage of economies of scale, as well as having one point of contact with one provider.
Where this type of commercial mortgage differs from a buy-to-let mortgage is scale. Generally it’s a setup that would be reserved for a full-time landlord with multiple properties, and wouldn’t be appropriate for a private individual acquiring their first rental property.
Auctions can be a quick way to get a property at a discounted price, and there are lenders who specialise in auction finance. Once you’ve made the winning bid, auction houses usually require the funds within 28 days, which means you have to move fast to secure funding.
Finding a lender who specialises in auction finance means you can get the money much quicker than the norm, so it’s the best route to take if you’re thinking about property auctions. It’s sometimes even possible to get the cash within a week.
There are also lenders who’ll give you finance before you attend an auction, so you can arrive prepared with an 'agreement in principle' — this type of arrangement can be particularly useful for experienced and established developers. But even in more challenging cases where finance isn’t in place, it’s occasionally possible to get funding for enthusiastic first-timers who have bought property at auction with only enough to cover the deposit!
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Bridging finance or development finance
The next type of funding within property is bridging or development finance. This can mean any short-term funding that helps pay for building and development costs. These two terms have significant overlap, and might seem interchangeable, but there are differences between the two. The main thing that determines if you need bridging finance or development finance is how ‘heavy’ the project will be.
How extensive are the building works going to be?
This is the most important question to ask before you explore your finance options for refurbishment or renovation. To determine what type of finance you need, it’s useful to think of projects in three broad categories:
This is the most straightforward type of project, where in general the main changes are aesthetic rather than structural, but may involve some internal work on floors, ceilings and walls.
Heavy refurbishment or renovation
As well as aesthetic changes, this could require moving internal walls, plumbing, or electrics, adding rooms and external walls, or even partial demolition and rebuilding.
The most involved type of property project, starting with an empty plot of land, or a very heavy refurbishment/conversion (for example, when nothing remains but stonework).
The terminology in property development isn’t rigorously defined, so what some people consider a ‘light refurb’ could be considered heavy by others — and somewhat confusingly, all of the above are types of ‘development’.
Property development finance in practice
Depending on the type of project you want to embark on, there’s a world of finance options available. You might want a 'refurbishment bridge', which funds 3–24 months of building costs and sometimes comes with the option to convert into a mortgage later on. This type of product would cover the majority of light and heavy refurbs.
Then for more extensive projects and ground-up developments, you can find 'development finance' to cover both land purchase and building costs. For example, if a developer wants to buy a plot of land for £100,000 and spend another £500,000 building properties on it, a lender might finance 50% of the plot purchase and 70% of the build.
In this example that would mean the developer would only need £200,000 of their own money, rather than the total of £600,000 that the whole project costs — freeing up their personal capital for other projects, or unexpected expenses.
Experienced developers who act as landlords can also use property they already own to secure lending. With enough equity free in your portfolio, you can get finance to buy more properties — allowing you to grow your property portfolio without having liquid cash.
As you can see, property development is a complex area, especially when it comes to finance. Ultimately, the best first step to take when determining what type of finance you need is to assess how extensive the project is, how long it will take, and how much it is likely to cost — in both the best- and worst-case scenario.
All successful property developers are good planners, and getting the right finance in place is a crucial ingredient in development success — whether you’re buying your company’s premises, or growing your rental portfolio.