The Benefits and Drawbacks of Development Finance
Development finance provides established property developers and construction companies with affordable short-term funding for most types of projects. Loan sizes vary from £50,000 to more than £50 million, with monthly interest as low as 0.5% (sometimes less).
Repaid promptly, development finance can be a uniquely cost-effective facility for covering the costs of ambitious and expensive property developments.
Even so, development finance is a product with its own unique pros and cons. Before submitting an application for development finance, it is important to discuss the advantages and disadvantages with your provider.
The Benefits of Development Finance
Just a few of the biggest benefits of development finance loans are as follows:
Rapid Access to Finance
Development finance loans can be organised and authorised much faster than any comparable loan or mortgage of a similar size. With all essential paperwork and documentation in place, the facility can be approved and the funds transferred within a few working days.
A Strictly Short-Term Product
Whereas most commercial mortgages and business loans take the form of long-term contractual agreements, development finance transactions are always wrapped up within 6 to 24 months.
Option to Roll up Interest
Borrowers typically have the option of being able to roll up all interest payments into the final balance payable. This means that no regular monthly repayments need to be made and the borrower’s cash flow can be optimised for the duration of the project.
Low Interest Rates
Exact borrowing costs vary from one lender to the next, but development finance is often charged at less than 0.5% per month; for longer agreements (taken out over 12 to 24 months), a fixed APR as low as 5% may be agreed.
Funding for Simultaneous High Value Projects
Development finance enables property developers and construction companies to conduct projects that would usually fall outside their on-hand budgets. It is also the only realistic option for those looking to execute multiple high-value projects at the same time.
A development finance loan can be taken out to fund almost any type of property development, including new-build construction projects. Depending on the borrower’s requirements and track record, it may even be possible to cover 100% of the project’s total cost with a development finance loan.
The Disadvantages of Development Finance
On the downside, there are several inherent drawbacks to development finance, which should be taken into account before applying:
Strict Lending Criteria
Most development finance specialists limit their services exclusively to experienced developers with an established track record. If you are a first-time developer looking to finance your first major project, you may find it difficult to qualify for development finance.
Funds Released in Instalments
Unlike most comparable products, development finance loans are issued over a series of instalments. Each instalment is tied with the completion of a specific project phase, overseen by the lender itself. Only when the issuer is confident that a key stage of the project has been completed will the next instalment of the loan be authorised.
Variable Fees and Costs
Development finance costs vary significantly from one lender to the next and have the potential to augment the value of a seemingly low-interest rate. Typical fees and charges include lender arrangement fees, legal fees, valuation fees, brokerage fees, completion fees and so on. Depending on the terms and conditions of your agreement, these fees could amount to anything from 1% to closer to 5% of the total loan value.
Exit Strategy Failure
If your planned exit strategy fails – i.e. how you planned to repay your loan – you will need to come up with a contingency plan as quickly as possible. Where development finance repayment deadlines are exceeded, penalty fees and higher rates of interest may apply.