The funding of the works would be paid to the investor in tranches, based on the schedule of costs submitted on an application. Funds would be repaid to the investor once the project develops, which is monitored by a quantity surveyor who inspects the project to ensure the funds have been spent as expected on behalf of the lender. The quantity surveyor also monitors the value during the project.
By using a loan-to-end-value limit, lenders protect themselves from any potential market twists or unexpected turns. An alternative way lenders look to finance development is with loan-to-cost ratios (LTC). This involves totalling the overall cost of the project and allowing a loan directly against this figure, which can vary from 55 per cent to 85 per cent, again all within an end value (GDV) parameter to ensure the project is not overfunded or the developer's numbers over ambitious.
The cost of development finance senior debt can also vary widely. Lower gearing requirements against the end values can allow an experienced developer to achieve 3 per cent to 5 per cent on funds, with total annual cost, inclusive of fees, about the 7 per cent mark. If developers lack experience and want higher leverage or to maximise their borrowing, then cost of funds can increase to 10 per cent to 13 per cent all-in.
Although this might look expensive, by using the leverage on offer the risk taken by the investor is minimised. However, the rewards are as attractive as ever, allowing any shrewd investor to overlook the price of funds and take their seat at the table on the end values.
There are further borrowing options in this sector made up of mezzanine finance and equity positions, which allow leveraging up to 90 per cent to 95 per cent of total cost for the right project. They all come at a price, of course.
When the cost is blended it represents an attractive possibility given the minimal exposure expected from the investor. A 5 per cent or 10 per cent stake for a potential return of 25 per cent to 35 per cent of end value is always going to attract attention. However, in using these funding options there are many mouths to feed via 2nd and 3rd charge positions and are normally only considered for larger scale projects.
With any investment, there is always a possibility that things might not work out as expected. Property refurbishment and development are no different. Exposure to the property market is an obvious risk, given the effect of any political change of direction, as well as the potential for domestic and worldwide events that can affect overall confidence.
There are also more doorstep risks. Cost of materials can increase unexpectedly during the process; values and demand might drop and overruns are certain to affect the margin with most developments. On a smaller scale, the contractors might not deliver what is expected and the designated timescale might have been too presumptive. All of these things will eat into the initial profit margin. Many pitfalls are present with property investment, but risk is measured with the potential rewards.
