Profit from property - financing options for development from Channel4.com/4Homes

The harsh truth about property development is that it needs money. From buying the site to the costs of fees, labour and materials, developing means investing a substantial sum to unlock the rewards.

1. Remortgaging
2. Residential or commercial?

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Remortgaging

Serial developers can fund a project using proceeds from the previous development. But even that requires skill, in order to tie buying and selling timetables together. For most developers, especially newcomers to the business, raising money is an essential part of the process, and one that will do much to affect eventual profits.

Developers’ sources of funding usually fall into two categories: private and commercial. The cheapest way to raise funds is always to use savings, as the rates earned on even a high interest savings account will be less than the interest charged on a mortgage or other loan. But the high cost of buying a property to refurbish means that few developers can afford to fund an entire project from cash.

Rising property prices have, though, opened up another financing option: remortgaging. Most homeowners will have built up substantial equity through house price inflation in the last few years. A larger mortgage lets homeowners release that equity for other purposes, including financing a second property. Remortgaging has the added advantage of raising finance at low, residential mortgage rates.

James Cotton, mortgage specialist at brokers London & Country, says that if someone raises extra money by remortgaging, the lender is unlikely to ask what the extra funds are for. The bank or building society’s main concern will be whether the new mortgage is affordable. As a rule, they will restrict lending to four times the main borrower’s salary. For the best rates, aim to borrow less than 90 per cent of the property’s value.

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Homeowners who do not want to move mortgages have the option of applying for a “further advance” from their lender. But this will usually be offered on the lender’s standard variable mortgage rate, which is the most expensive way to borrow. The lender is also more likely to ask questions about how the money will be spent, although buying a second property is generally accepted as grounds for a further advance.

Although raising finance through a residential mortgage is possible, developers have particular requirements which are quite different to those of an owner-occupier. A standard, 25-year mortgage term, for example, is not suitable for a developer who plans to sell the property when it is finished, unless they can roll the funds over into a new project.

At London & Country, Cotton advises that developers should pick a mortgage with no early redemption penalties, such as a tracker or flexible mortgage. This allows a developer to pay back some or all of the loan without facing extra charges. These charges can be high: a fixed rate mortgage could have redemption penalties of six months’ interest.

Some lenders, such as Northern Rock, allow repayments without penalty as long as the mortgage is not cleared in full, even with a fixed rate, flexible mortgage. This could be a good option. Another useful way to finance development is to make overpayments into a flexible mortgage. The developer can then draw on this money without going back to the bank for a further advance. Used carefully, a flexible mortgage can be a good source of working capital for a developer.

Financial arrangements, as much as design and finish, can make or break a development so it is vital to take professional advice. Expect to pay up to one per cent of the mortgage sum to a broker, although many charge less.

Residential or commercial?

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