Why Development Finance is the Way Forward

The Future of Property Investing: Why Development Finance is the Way Forward

Investing in buy-to-let properties is arguably less attractive than it has ever been. Increases in land tax rates, reductions in landlord tax relief, the ever-increasing regulatory requirements and rent controls as well as, simply put, the affordability of typically low risk properties all contribute towards a growing need to look outside the box.

One route to attractive returns is to seek out property development opportunities through third-party finance. It is worth looking at the overall structure of this type of transaction.

The purchaser is often a special purpose vehicle (SPV), that often being a new standalone company or subsidiary of another company. This can have benefits to both borrowers and lenders in different ways. From the borrower’s perspective, it limits the potential liability that a lender would have if enforcement action is taken. For a lender, it is clear to assess whether or not such SPV is a safe investment.

One of the key considerations to look at is the security package itself which typically gives the lender a degree of control over the potential dealings the borrower could have over the asset. A lender will typically consider where the value lies, a standard security will be used and will be fixed to the property itself whereas a floating charge will lie over the SPV.

The standard security would need to allow for the intended development to be carried out and will likely require various insurances are in place throughout the process. The value attached to the borrowing is likely to be linked to the future value of the site after development since it is typically starting off as a derelict building or piece of land. This exposes the lender to a high level of risk at the development stage which will mean the lender will want to be party to the various building documents and processes.

An Assignation in Security will allow the lender to effectively take control of contractual rights. That will allow the borrower to transfer their rights under the development contracts to the lender until the lender’s debts are paid. The borrower does, however, typically allow the borrower to administer and perform the contract on a day-to-day basis until there is a default.

A lender is also likely to seek warranties from the development parties to ensure they have direct rights with those parties.

A floating charge allows the lender to hold a security over the overall assets of a company. These are likely to be limited in the case of an SPV, but a lender may well look to have in place such an agreement. This will restrict the borrower from dealing with their assets without the lender’s consent.

A lender will in most cases seek out additional credit support, often through personal guarantees issued by the company Directors.

An essential part of any development finance transaction will be the agreement of Conditions Precedent (CPs) where a list of conditions that require to be satisfied before a borrower can draw a loan are agreed. These are often set out as a schedule to the facility agreement itself. This will form a key part of the lender’s credit appraisal before releasing funds Borrowers would need to keep the lender well informed of progress throughout the development.

The borrower will often be asked to produce documents such as valuations, insurance documents, development documents, reports on various elements of the property title and other surveys.

It is very common in such transactions for the finance agreement to facilitate agreed sums to be drawn down in various tranches. This will often allow for funds to be made available to purchase the subjects in the first instance, then to secure funds to carry out various stages of the development.

It is also common for there to be agreed Conditions Subsequent where post completion conditions are agreed. These too will form part of the facilities agreement.

Finally, is the small matter of making the development income generating. This will often require a managing agent to be appointed to collect and administer rents. This too would typically be reviewed by the lender.

In short, the current landscape of property investment may well push some to look at higher risk development deals rather than more typical property purchases with tenants in situ. These certainly do come with added complexities but having clear structures in place at the outset can make the assessment of the potential value of an investment far clearer and perhaps very fruitful.

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