#propertydevelopmentfinance

Overview

Property development finance relates to any money or capital required to fund the development of a property or site of properties. It tends to run as its own industry within finance ranging from the smallest refurbishments to large scale multi-house sites.

The industry is considered “non-regulated” meaning that it does not have to adhere to the stricter lending criteria of, say, mortgages because property developers are considered professionals (whereas mortgages are used by homeowners - not business-related) - and development finances always requires lending to a corporate body - a company, as opposed to an individual.

There are various elements to property development finance, which are known as “tranches” (the French word for “slices”). These slices are defined by their risk and return - where a higher risk will generate a higher return and a lower risk will generate a lower return but have more security (probability of being paid back). These tranches are known as senior debt, mezzanine / junior debt and equity - each of these can also be subdivided to give specific types (such as “stretched” senior debt).

The correct use of each type of tranche can be used to generate the preferred outcome of the funding - from cheapest funding to highest potential profit. The property development industry - being driven by security and returns on lending, can and has traditionally been very difficult to infiltrate and rarely consistent to borrowers due to it’s levels of complexity and lack of ways to learn.

PROPERTY DEVELOPMENT

What is Senior debt?

Senior debt forms the largest part of development finance as it is the biggest tranche, usually lent by banks and specific lending institutions - most similar to mortgages. Banks that hold significant client money (from saving accounts etc.) look to then deploy that money it holds, in order to make a return on it. These deployments of funds will range from very low risk (but high security, such as bonds) to higher risk lending such as development finance.

Senior debt is generally defined as “last money in, first money out” and makes up the largest part of the costs of a project, typically 60% to 90%. The balance of the costs (the “shortfall”) will have to be made up by the developer, known as the equity.

The senior debt lender will have professionals produce reports on the value of the land/development, the costs of the proposed works and any legal matters around a sire or borrower. Once content with these, they will lend the money on a fixed interest rate (known as a “coupon”) which is usually between 4% and 12% - according to the perceived risk. This interest is usually rolled-up, so the borrower does not have to pay monthly (or “service”) interest like a mortgage but allows the developer to pay back the loan (“principle”) and rolled interest at the end of the project, out of the profits.