Bringing a development project from groundbreaking to completion takes a great deal of capital; beyond acquiring land, hiring workers and equipment and paying for materials, there are hundreds of other smaller expenses such as zoning fees, legal costs and tax bills, not to mention the administrative costs of keeping a development project on track. Construction finance is used to help cover these costs by financing the work necessary to bring a project to life, and can be used for projects of any size. Because mortgages can’t be obtained for any uninhabitable property, construction finance lenders provide an important way for property developers to put the wheels in motion when beginning a new project.
Construction finance differs from other types of development finance in that it’s specifically designed for new-build structures, not for renovation or refurbishment as with some other types of finance. Loans that are specifically designed for construction are a better fit for the needs of these developers, and lenders with experience working in this sector are better able to advise customers on the types of loan that are most appropriate for their needs. While construction finance is in many cases a necessary element of a development project, it’s important to bear in mind that there are many different products available in the market; there is no single approach to lending, and each financier has its own approach. With that being the case, developers seeking construction finance should consult a financial advisor with experience of the construction sector before committing to any form of loan.
Property developers need to keep their capital investment to a minimum when taking on a project. While a certain level of cash is needed to move development forward the more that becomes tied up in property, the harder it is for the developer to remain flexible. They may need to use this capital for other purposes, so it’s vital that developers avoid committing capital unnecessarily to a project. Construction finance is therefore an important part of a successful development project because it fulfils the need for property developers to remain financially agile.
Construction finance is used to escalate a project from beginning to completion, and while it may not be the sole loan used in this process it will generally provide the backbone to the project’s development. Construction finance is generally sought once a plot has been identified and purchased (often with the use of site acquisition finance), and pays for work to actually get started. The money provided for construction finance will be used to pay for the actual building work to begin, and for any work that’s carried out subsequently. This may not include other expenses that must be covered, such as tax bills and admin fees, so it’s important that developers make sure they have alternate source of finance to meet these costs.
Construction finance is a form of development finance, and as such can be obtained through many of the UK’s bridging loan providers. These lenders specialise in providing high-value short-term loans to meet specific needs - in this case, to finance the construction of property. They operate by securing their loans against an asset, which in most cases consists of the property under construction, but they are also able to take other assets as security as well. These lenders then provide the necessary capital to ensure the project is completed, and the borrower then repays the loan once the project is finished.
The way in which the borrower repays their loan is known as their exit strategy. Most commonly, this will either be through the sale or the mortgaging of the property, depending on the developer’s objectives, and the borrower’s exit strategy will be thoroughly assessed before their application is approved.
As mentioned above, the most common form of asset secured by development financiers is the property being constructed, but this clearly leaves them vulnerable; the lender is relying on selling the property if their loan isn’t paid back, but if the property is never actually finished they can’t easily sell it and reclaim their money. For instance, if they’ve put up £5 million to finance a new development that only reaches half-completion, they won’t be able to sell the properties for £5 million, since no-one’s going to pay full whack for half-finished homes.
For this reason, construction finance lenders require their clients to have extensive experience within the industry, and a proven track record of successful developments (or at least that they’re employing someone with such a track record). In addition, the lender may require additional security in the form of other assets such as other developments, which will allow them to reclaim their money in the event of a failed project.
There are no hard and fast rules on the terms of construction finance, and each lender has their own approach. However, there is some common ground between all lenders in this sector, and one of their first concerns will be for the personal experience of whoever’s taking on the project. An ideal outcome for any lender is a project that completes on schedule, with a bulletproof exit strategy to repay the loan on time. Lenders will want to see evidence that the developer can and will escalate the project on time, and will have no difficulties selling or refinancing it once the time comes. This requires careful calculation on the part of both the lender and the borrower, because an amount of guesswork is involved; there’s no point building a house for £500,000 if it can’t be sold for more than £400,000, so a comprehensive understanding of the local real estate market is vital.
Construction finance is a highly flexible and adaptable tool that enables property developers to work quickly and confidently to bring profitable projects to the market. The ability of these lenders to work with their clients and develop lending packages tailored to their needs makes it an invaluable asset when it comes to property development.
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