The term 'investment' can be interpreted in many ways. Few would dispute that diversification is the correct way to plan a good investment strategy; and in today’s financial world investors have several choices available.
Of the various asset classes and sub classes in each category, property development stands out. It represents a very different and visible option. Some investors like to be able to “kick the tyres” and seeing a project develop from an architect’s proposed plan to a completed development is extremely satisfying.
In principle, there is little difference between developing a property and investing in the markets or anywhere else. As with any investment, it is about the risk taken against the potential rewards gained. Some would also say that within the associated costs there is also a certain parity.
If one compares percentage fees with purchasing and developing a property to annual management fees and other costs of running a robust portfolio, then in some cases they are not dissimilar. The one fundamental difference of investing in property development is the option of gearing. Borrowing to invest allows exposure to larger returns from a relatively small upfront contribution.
From refurbishing and selling a property to purchasing land and submitting a planning application, there are many options from a financing perspective. The types of loans that are available include refurbishment loans, both light and heavy, dependent on the work volume and the use of planning or not. There are also full development loans, which are backed by planning applications and detailed analysis to illustrate that the numbers reflect correct cost and market conditions.
These types of funding options are aimed at those wanting to venture into property investment, from first-timers refurbishing a buy-to-let property to large corporate developers. The funding is normally underwritten on the strength of the numbers provided within the required schedule of cost and schedule of works, which are provided by the applicant or their contractors. These documents help the lender understand how the timeframe and cost will be met and managed.
As with any numbers, they do not lie, and ambitious projects can easily be picked up on by the lenders and rejected at this stage. The other important key is the experience of the applicant. A first-time investor with no experience of property development means the underwriting will be heavily concentrated on the contractors behind the project.
This is to ensure there is relevant understanding of the works expected. In this situation normally cost is increased to reflect the risk from the lender's side. Experience is key.
Key points
- Property development is an increasingly popular form of investment
- There are funding options available aimed at investors interested in property development
- One way lenders look to finance development are loan-to-cost ratios (LTC)
Development finance is made up of a senior debt or first charge lending position. This comes in the form of a land loan, which usually consists of 65 per cent to 70 per cent of current market value. This would be classed as the acquisition loan, followed by potentially fully funding the cost of works within a set parameter based on the end value or gross development value (GDV).
