Property development is an industry with the opportunity for huge returns. But it can also demand developers to put in large sums of money to finance projects. This doesn’t have to be prohibitive; there are a number of options when it comes to commercial property development finance.
Choosing the right way to finance your project depends on the project itself, as well as your risk appetite, personal financial liquidity, and how much control and ownership over the project that you wish to retain.
What is the best way to finance property development?
Proper developers often use a combination of debt and equity to raise capital for their developments. Debt means borrowing money from a third party, while equity involves raising money by selling a stake or a share in the project.
Debt
The main advantage of taking on debt rather than equity financing is that you retain ownership and control over the project. That means any profit made out of the development is entirely yours. Structuring your financing through debt also means that your costs are predictable; you know what you owe and how and when you have to pay it back.
The disadvantage is that paying interest on a debt can cut into the overall profitability of your development. In addition to having to repay the loan, your lender may also ask for terms that restrict your ability to do what you want.
Equity financing
The advantages of equity financing your project is that you do not have any repayments, which improves your cash flow during the project. This reduces your risk levels and also could grant you access to equity partners with expertise or contacts to assist you.
The disadvantage is that by sharing ownership, you’re sharing control, and also diluting your profit potential.
Types of loan
If you decide to use debt as your preferred method of financing, there are different types of loans available.
Construction loan
A construction loan is a short-term loan purely to finance building or major renovation. Unlike a mortgage, where a lump sum is provided in order to purchase your home, a construction loan consists of a series of drawdowns or progress payments that align with the stages of building completion.
Often, a construction loan is then converted into a mortgage when the project has been completed.
Bridging loan
The clue is in the title for a bridging loan - a loan that bridges the gap between buying/developing a new property and selling an existing one. You could apply for a temporary bridging loan if you are purchasing a new property or site before the funds from an existing one have cleared.
Loan against existing assets
Taking out a loan against existing assets means putting up something you already own, like a home or existing property, as a collateral for a fresh loan, reducing the risk for the lender.
Private loan
A private loan usually comes from a source other than a traditional bank, for example an individual or private company, which means the terms can be quite different. Often these types of loans have faster approval times but come up with shorter terms or higher interest rates, so make sure you understand the terms and conditions your private lender is offering before you agree.
Types of equity investment
Just as there are different types of loan, there is a variety of equity investment available.
Equity funds
An equity, or property fund, means a team or group of people pool funds and buy a stake in a development project. The size of the fund determines the size of the stake that the fund purchases. If the fund is large enough, it can control an entire development.
Equity funds are a good way for people with limited capital to get involved in property development.
Equity investor
Equity investors are likely high net worth individuals or family offices who invest a portion of their funds into property development projects in return for a share of the profit.
Raising financing for property development
If you’re looking to secure finance, it’s important to do your research. This is for two reasons; firstly, so that you can secure finance but also, perhaps more importantly, to make sure you understand exactly what you need.
Understand your needs
When it comes to understanding your needs, it can help to break things down.
Costs involved
The first thing you need to understand is exactly what costs are involved. When examining costs, always build in additional budget for delays. Having a contingency fund to cover when things don’t go to plan will save you money in the long run.
Understand your timeline
It also helps to have a clear idea of your anticipated timeline and all the things that could delay it. Property development can be a lengthy process and you need to be aware of the timeframe involved.
Understand the cash flow
Being aware of your cash flow and ensuring you have enough liquidity to keep the project moving is also an important thing to understand.
Create a detailed business plan
Creating a detailed business plan won’t just help you attract an investor, it will clarify things in your own head as well. Getting everything lined up and having complete oversight over your project from the outset sets you on the path to success.
Consult a professional
It can help to consult a professional. Choose a company that has experience in building or financing in your area and you may be able to troubleshoot potential issues before they even arise.
At Novus Projects, we have over 30 years of experience in the property building world and have dealt with multitudes of different scopes and projects. We’re happy to discuss your plans and ideas as you move forward with your project.
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We can provide a detailed quote (or tender) on your own plans. Contact us today to discuss how we can help bring your vision to life.