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Property Finance

Property Finance 

We take a look at property finance with Kal Woodley.

What is a bridging loan and how do they work?

Put simply, it’s a short term financing product. Every bridging loan is a means to an end. It’s by no means a long-term solution. We’ve always got to make sure we’ve thought about what the bridging loan is for and what you will be doing whilst the bridging loan is in place. 

With bridging loans you typically borrow against the market value of a property, although some lenders can do below market value. You can use bridging loans to purchase different types of property, for various reasons. 

They are commonly used for auction purchases where you’ve got to complete within a specific timeframe. Another example is probate, where you might be about to inherit property and you’ve got an inheritance tax bill. If you don’t have the cash to pay that tax bill you can use a bridging loan to take capital or equity out of the property to settle it. 

One of the original reasons for bridging loans was to help if you’re in a property chain. Let’s say there are five people within the chain – you may come under pressure to complete your purchase as soon as possible, or risk losing the property. Bridging loans were bought in around 2008 for this purpose.

Property developers use bridging loans for buying land and seeking planning permission, which increases the perceived market value. You can use that new market value to gear your loan higher and start building. You can be quite creative in what you can do with them. 

You can use bridging loans for unmortgageable property that doesn’t have a kitchen, bathroom or running water. You want to fix it up and then remortgage it later on or put it on the market. Bridging has a lot of uses and is very flexible.

What is the exit strategy?

A bridging loan is temporary. We don’t put someone on a bridging loan if we don’t know how to get them off it. That’s the golden rule. I always tend to work backwards: if a client comes to me wanting to buy and renovate a property to sell, I’ll look at how much it will be worth once complete. 

Let’s say it’s going to be £100,000. It might take an average of three months to sell. It might take three months for the construction work – so we now know we need a bridging loan for a minimum of six months. That’s the minimum timeframe.

Then we look at the purchase cost, let’s say £50,000 in this example. The cost of the work is £25,000. So the client needs to borrow £75,000 and will sell it on the market for £100,000. 

A common mistake is to purchase a property, put the work in, but perhaps the rental income you’re going to get from the property doesn’t support the refinancing loan you need to repay the bridging loan. Then you’re stuck with a decision – whether to put more money back in the scheme to lower the Loan to Value, or put it on the market when you’ve not accounted for a sale. 

So your exit strategy is essential. It’s your profit at the end of the day. If you can’t work your way backwards to build it, then the whole scheme just falls down and you can find yourself in a sticky situation.

What are first charge and second charge with a bridging Loan?

It’s what we call the Deed of Priority. Your mortgage tends to be a first charge mortgage. In the event of a repossession the first charge lender has priority. They recuperate the loan they’ve given you and any other costs first. A second charge holder is second on the list.

Something that’s not always clearly explained is that it’s not so easy to bolt on a second charge. You’ve got to seek permission from the first charge lender. 

But there is a time and a place for a second charge. If you are on a first charge mortgage, for example, with an amazing rate, and you only need a second charge for short-term purposes, it can be more cost efficient to take a second charge loan. 

Otherwise you need to refinance the whole property, raise capital and be stuck on a more expensive financing rate for the longer term. A mortgage broker would work out if it’s more cost efficient to do a second charge. 

What is 100% development finance or joint venture development finance? 

I work with developers every day and they differ in size and experience and background. Development finance is a mechanism that is constantly changing and moving. 

With a bridging loan, a lender will lend you money against the market value of the property. They will happily lend you 50% to 70% Loan to Value. 

But let’s say you want to purchase a property at £100,000 but converting it will cost you another £100,000, so you want to borrow more than the asset is currently worth. A bridging loan doesn’t work here because you’re exceeding market value. 

With development finance you borrow against the Gross Development Value – what the asset will be worth in the future when the work is finished. They’ll go through those costs with you to make sure there is value for money. 

They will give you tolerance. You don’t have to be bang on. They use market comparables to help with valuation, or other calculations to get a value. Development finance is basically a way of borrowing what you need that far exceeds the current market value of the property, to deliver something that’s worth more in the future.  It’s not straightforward. I’m still learning myself.

Can you get 100% development finance?

This is one of the most Googled searches. I want to be open and realistic here. A 100% development finance in terms of all debt does not exist. I have never found a lending source that will give you 100% of the money without you putting a penny in.

But if you have other assets – say you’ve got four or five other properties in your portfolio, you can leverage against those. 

Most development finance lenders are not keen to support a scheme where the developer puts no money in. You’ve got to put ‘skin in the game’. Why should they take 100% of the risk? If there’s a cost overrun and your contractor needs another £50,000, you’ve got to have that asset worth behind you to cover that. 

Some developers then alternatively turn towards investors or Joint Venture Partners. That’s absolutely fine. But investors aren’t just waiting in line ready to give you their money. We need to find that investor and pitch to them. It has to make sense to the investor and that the overall risk is to their liking. 

JV partners are probably a little bit easier to come by. If you’ve got 50% of what you need into the scheme and they bring the other 50%, that’s a lot easier to broker. It also helps if one of the JV partners is a seasoned developer or a contractor developer. 

What is Mezzanine Finance?

Let’s say you are going to buy a property for £100,000 and you find a bridging lender that will give you £75,000. You’ve only got £20,000 so you’re short £5,000 A mezzanine lender would sit behind the bridging lender, almost like a second charge, and top up your borrowing. 

Mezzanine lenders are a lot more relaxed in comparison with a bridging lender. They’re usually small institutional outfits, people with their own money or that pool money to get a decent return on investment. They look at the overall debt leveraging position and the experience of the client to make sure that it’s right for them. 

There are advantages and disadvantages. It helps you close the gap and gets you underway, but it’s not cheap and they want a decent return. I’ve seen interest rates go up to 20% to 25% on small loans. Typically you might borrow £50,000 to £100,000 up to a maximum of £250,000. 

So you need to make sure how much you will eat into your profits and weigh up that decision.

How long does property finance take to arrange?

It varies tremendously. You might see online people saying they did a bridging loan within three days – but I’ve never managed to do it so fast. 

Preparation is absolutely key, especially if you want to move quickly. Get everything ready. Drip feeding information to your broker or lender is painful and underwriters don’t like it. 

We will do our best to move quickly, but a lot of clients do leave it late. It takes time for your broker to source you a good deal. The lender then has to have a look at it and come back to you with a yes or no, usually in the form of an Agreement in Principle. 

Then you move on to valuation. The lender will trigger the valuer who is a separate entity – so it’s subject to their availability. Some valuers are not even available for three weeks. They need a week or two to generate and return their report. Then you’ve got legals – which is more detailed than with standard mortgages. There’s much more paperwork and searches take a long time. 

When you look at everything involved you’re looking at two to four months. On bigger schemes it could take six months to do a development financing deal.

What if I have bad credit – how does this affect me getting property finance?

Bridging lenders and development lenders all have their own criteria. They have their own ideas of how they want to grow, the market sector they want to service and the type of clients they want. 

If you’ve got bad credit there are bridging lenders and development lenders that will quite happily help you if the scheme makes sense, and you’ve got enough experience or a decent net asset worth behind you. 

A good broker is able to talk directly to the underwriter and help move things along. Bad credit isn’t the end of the world when it comes to bridging and development. You just need to find the right lender for the scheme.

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How much does property finance cost?

People who have never done bridging or development before think that these financial products are exactly like mortgages. But that’s far from the case. 

With standard mortgages from high street lenders you can get free legals and free valuation, but that doesn’t happen in the bridging and development world. People can be shocked by the costs involved. 

I’ve never seen a valuation below £500 and they can go into the thousands. They’re doing thorough background checks. I’ve seen mortgage valuations on a single piece of paper but bridging and development valuation can be about 30 pages long. They are detailed reports. So as soon as you’ve located a lender try and get an idea of the valuation costs to prepare yourself. 

When it comes to the legalities this is also another shock. You have to pay the lender’s legal fees, not just your own. The lender will come back with a cost for the valuation and legals. You can always push back on it. But you have to provide the ‘undertaking’ to your solicitors where you agree to pay the lender’s solicitors’ fee regardless if the deal goes through or not.  It can mount up in terms of costs. 

Don’t try to compare bridging loans and development finance with a mortgage. They are two different things – short-term versus long-term financing. A lender needs to make money on the short term deal. They’re not in it for a 20 or 30 year return.

How do you apply for property finance?

I started off in mortgages and moved to more complex lending and property finance. There’s a lot of information out there on mortgages, but when it comes to bridging and development it’s a huge marketplace that’s constantly evolving. 

A lender can change their criteria in the blink of an eye. They don’t send market updates like mortgage lenders. They just change. 

You could Google property finance but you’ll only see a snippet of what’s out there. There’s no comparison site you can use to fully appreciate what’s out there. A good broker knows the market and can pick up the phone to the underwriter and discuss your deal.

We can even try and place it there and then. We soften the blow and make it an easier process. I’ve seen developers get it right, and I’ve seen developers get it horribly wrong. We know how to approach lenders and help you prepare. I always work with my clients to prepare them, make sure they’re aware of the costs and the timeframe.

Have an appraisal ready. Go on to some property sites and see what the marketplace is doing in terms of values. Make sure you’ve got the purchase cost, the cost of work with one or two contractors with indicative terms and what you can sell it for. Work out the timeframe to either sell it or refinance it. It doesn’t have to be chapter and verse – your broker will help you put that together. I write appraisals for a lot of my developers. 

Speak to your broker as early as possible. Do not leave your financing to the last minute.

I can start to talk to a couple of lenders for a heads up.

As a broker, a real big no-no in this market is where property developers flood the market. They have a scheme and send it to five or six brokers. Because we’re all fishing in the same pool, the lenders will notice that. Lenders are quite loyal to their brokers – it’s a very nice relationship. If they see a scheme that’s coming in from different brokers they will just shut the doors and say they’re not interested – even if it’s a great scheme. They don’t want to get into a pricing war.

A final point is to be realistic if you’re new to development. A lender won’t help you on a million pound scheme if you’ve never done this before. But if you want to do a couple of refurbs or build your first ground-up development, there are lenders out there that will support you. But not every opportunity that comes by is going to be deliverable. I always stress that to new developers that come into the market.