Types of development finance explained

Land finance without planning permission

This is finance to buy land before planning has been granted, usually because you expect to add value by securing it. Lenders value the land at its current use, not its potential, so they lend less and you'll need to put in more of your own money.

Things to check:

• Planning almost always takes longer than expected. Budget for extra months of interest.
• Have a fallback. Lenders will ask what you'll do if planning is refused: sell the land, hold it or use it another way.

Development finance

This is the main loan that pays for the build. It usually covers part of the land cost and most of the construction costs, and it's often called senior debt because it has first charge over the site.

The money isn't released in one go. A monitoring surveyor, appointed by the lender, visits the site at each stage and confirms the work has been done before the next tranche is paid. Interest is normally rolled up and repaid when the loan is cleared, so you don't make monthly payments while you build.

Lenders look at the loan against the total cost of the project and against the gross development value (GDV), which is what the finished scheme is expected to be worth.

Things to check:

• Your contingency. Lenders expect one, and projects without a realistic buffer are the ones that run into trouble.
• Your professional team. The contractor, architect and quantity surveyor all affect how a lender sees the risk.
• Your experience. First-time developers can get funded, but may be offered less or be asked to use a contractor on a fixed-price contract.
• In Scotland, the building warrant needs to be in place before the first drawdown.

Mezzanine finance

Mezzanine is a second loan that sits behind the senior development loan. It fills part of the gap between what the senior lender will lend and the total cost, so you need to put in less of your own cash.

Because the mezzanine lender is second in line to be repaid, it's more expensive than senior debt. Developers use it when they'd rather keep capital free for their next site than tie it all up in one project.

Things to check:

• Run the numbers with the mezzanine costs included. Borrowing more only makes sense if the profit left at the end still justifies the risk.
• Not every senior lender will allow a second charge behind them. The two loans need to be arranged together.
• Higher borrowing leaves less room if costs rise or sale prices drop.

Finish and exit finance

Finish and exit finance is for projects that have stalled or run short of money before completion. A new lender repays the existing loan, provides the funds to finish the build, and then gives you time after completion to sell or refinance.

It's used when the original lender won't release any more money, when costs have overrun, or when a project has sat unfinished for a while.

Things to check:

• Expect the new lender to ask why the project stalled and what's different this time.
• You'll need an up-to-date cost to complete, ideally from a quantity surveyor.
• Act early. The longer a stalled site sits, the fewer options there are.

Development exit finance

Development exit finance is a short-term loan taken when a build is finished, or very nearly finished, to repay the development lender. It gives you more time to sell or let the units without running into default interest or extension fees on the original loan.

Because the construction risk has gone, exit loans are usually cheaper than development finance. Many developers also use them to release some profit early and put it into their next project.

Things to check:

• Arrange it before your development loan term ends, not after.
• Lenders will want to see that the build is complete. In Scotland that means completion certificates from the local authority.
• Have a realistic sales or letting plan backed by local evidence.

How the different loans fit together

Take a developer buying a site with planning for six houses. They might buy the land with a bridging loan to secure it quickly, refinance into a development loan when the building warrant comes through, and take a development exit loan when the houses are finished, so they aren't forced to sell below value while the development loan runs out.

Each step is a separate loan, but they need to be planned as one. Gaps between facilities are where projects get expensive.

What to think about before you borrow

• Work out your exit first. Every lender will ask how the loan gets repaid, and a vague answer is the most common reason cases stall.
• Look at the full cost, not the headline rate. Arrangement fees, exit fees, monitoring surveyor costs, valuation, legal fees and rolled-up interest all add up.
• Build in time as well as money. Delays cost interest.
• Choose a lender that has done schemes like yours before. The cheapest offer doesn't help if the lender is slow to release funds.

Why developers use Fundamenta

We worked for lenders for years before we started broking, assessing and structuring property finance cases from the inside. That changes how we put a case together. We know what a credit committee will question, so the answers are in the application before it's submitted.

We also know that lender appetite varies a lot. Some lenders like small schemes, some only look at larger ones, and some won't lend in Scotland at all. We match your project to lenders who want that type of deal and who we'd expect to deliver.

And we look at the whole project, from buying the land to repaying the final loan, so each stage is lined up before the first one starts. If your project is in Scotland, our page on development finance in Scotland covers the points specific to Scottish schemes.

Common questions