Are you looking to develop property, but unsure which type of funding is right for you? In this article, we look at what options are available to you, the pros and cons of each, how to decide which is the most suitable and where to access it.

Who is this aimed at?

In this scenario we are reviewing funding for developers who purchase land and build from the ground up, or work on large conversions like permitted development schemes and looking for a loan from £100k up to £20m.  The different funding options available will largely depend on the levels of equity that the developer can provide on day one.

Types of funding available:

1. Pure Equity or Joint venture funding

2. Peer to peer/crowdfunding

3. Straight senior debt

4. Senior debt and mezzanine debt

Pure Equity or Joint venture funding

Pure Equity or Joint venture funding is where one party finds the opportunity but does not have the money to complete the development. They seek a second party who has the money and in return for providing this “equity” usually wants a profit share.

Pros:

• The equity partner shares in the risk of the project. In a downturn if the eventual sale price is less than the overall costs, the losses are shared by both parties in the pre-agreed ratio.

• The Developer can retain complete control over a project and the site cannot be repossessed in a downturn.

Cons:

• The high ‘price’ of this equity – i.e. the profit share, will normally far exceed the costs of alternative funding options such as debt.

Who is it most suitable for?

Developers who are risk averse, are happy to sacrifice overall returns for control and may lack experience in the debt market.

Peer to peer/crowdfunding

Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman.  P2P websites have greatly increased its adoption as an alternative method of financing.

Pros:

• Competitive interest rates.

Cons:

• Time taken to draw down as the funding is usually raised after the proposal has been made.

• This is difficult for development loans where money is drawn down over different stages as you need to have all of the money pledged before an initial drawdown can be made, therefore negating any cheaper rate gains.

Who is it most suitable for?

This type of funding is better for finished investment properties where all of the funds are required on day one.

Straight senior debt

Straight senior debt is where the lender takes a first charge over a site and charges a fee and interest for the duration of the loan.

Pros:

• Normally the cheapest way of funding a development, giving the developer the highest returns.

• Allows a developer to stretch their equity across more than one project thereby maximising their returns.

Cons:

• In the event of default you risk ceding control to the funder

• Requires the developer to have some equity as most senior lenders are not prepared to put in 100% of the costs or exceed 60% of the GDV.

 Who is it most suitable for?

Developers who own a site with planning and little or no debt. Where their equity is in the property and the remaining funds required will deliver a finished product within the senior debt providers lending criteria.

Senior debt and mezzanine debt

Senior debt and mezzanine debt are where you have more than one lender. Both lenders require a charge over a property with one lender ranking in front of the other.

Pros:

• This is cheaper than the pure equity route and allows the developer to stretch their funding if a senior lender cannot quite provide all of the funds required.

• Allows a developer to stretch their equity across more than one project thereby maximising their returns

Cons:

• In the event of default, you risk ceding control to the funder.

• Higher transactional costs as multiple parties involved.

Who is it most suitable for?

Developers with little or no equity, with a number of projects over which to spread equity, who have negotiated vendor deferral of some of the sale proceeds.

Summary

Firstly, decide how much equity you are prepared to put into a project and what your personal trade off is between returns and control. From here you should be able to determine which type of finance is most suitable for your project.

RQ Capital is a short term property funding company that provides both bridging and property development loans.  This article is the view of its Directors only and gained from their combined expertise over 50 years involvement in property as developers, borrowers and now lenders.

We believe in honest, transparent communication and building long term business relationships. We connect you directly with our decision makers who take the time to understand your vision and offer the loan to fit your development project.