Development finance: pros, cons and common mistakes

The advantages

• Leverage: lenders commonly fund most of the build and part of the land, so your equity goes further and you can run more projects
• Pay for what you use: interest accrues only on funds drawn, from the date each is drawn
• No monthly payments in most cases: interest is usually rolled up and repaid from sales or refinance
• Independent oversight: the lender's valuer and monitoring surveyor test your numbers and progress, which can catch problems early
• Flexible structures: senior debt can be combined with stretch senior, mezzanine or equity to reduce the cash you need; see the capital stack explained

The disadvantages

• Cost: rates, arrangement and exit fees, monitoring and valuation make it more expensive than investment mortgages
• Releases in arrears: you or your contractor carry each stage before it is reimbursed
• Cost overruns are yours: lenders normally expect you to fund any overrun before further releases
• Fixed term: if the build or sales run late, extension fees and default interest follow
• Security and guarantees: the lender takes a charge over the site, often a debenture over the SPV and personal guarantees from directors
• Valuation risk: a lower GDV at valuation or during the build can reduce the facility

Appraisal mistakes

• Optimistic GDV: using asking prices or the best comparable rather than achieved prices for similar new-build units
• Thin build costs: a builder's estimate without a quantity surveyor's review, or no allowance for inflation over the programme
• Missing costs: professional fees, warranties, utility connections, section 106 and CIL, building control, insurance, sales and marketing, and stamp duty on the land
• Finance understated: interest worked out on a straight line when the lender forecasts on an S-curve, or no allowance for the sales period
• No or token contingency: commonly 5% to 10% of build cost is expected, more for conversions
• VAT treated wrongly: some costs on conversions and commercial schemes carry VAT that may not be recoverable

See how to write a development appraisal and GDV explained.

Planning and site mistakes

• Buying on assumptions about planning, then finding the consent or conditions cost more than expected
• Not budgeting for biodiversity net gain or nutrient neutrality mitigation; see biodiversity net gain and nutrient neutrality
• Skipping site investigations, so ground conditions, drainage or contamination surprise the budget
• Underestimating time to discharge pre-commencement conditions, which delays the first drawdown

Finance and delivery mistakes

• Choosing on rate alone, ignoring the net loan, fee basis and cash you must put in; see ROCE and the true cost of development finance
• A term with no slack for build or sales delays
• No working capital to carry costs between drawdowns
• Changing the design or contractor without lender approval
• Leaving the exit until the end, rather than lining up agents, valuations or a development exit loan as practical completion nears
• An inexperienced team on a complex scheme; see what development lenders look for

Is development finance risky?

Any development carries risk, and finance amplifies the result in both directions. With realistic numbers, a contingency, an experienced team and a term with room to spare, the risk is manageable and the leverage can sharply improve your return. Without them, a modest overrun or a slow market can absorb the profit. Test your numbers on our development calculator, then compare development lenders on Instant Quotes and apply online.

Common questions

This guide is for general information only and should not be treated as legal, tax or financial advice. Lender requirements depend on the property and your circumstances.