This needs to be broken down into two sections. Funds are required to buy the land and cash-flow/funding is needed to build the development.
Buying the land
The developer will set up an SPV so each development site has its own entity and depending on how the build is funded the developer will ring-fence the monies used exclusively for a development.
Commonly the land is purchased with use of:
- Profit made from the last completed development
- A Bridge-Loan (see below)
- An investor or consortium of investors seeking a return once the project is complete
- An investor or consortium that will buy the freehold from the developer
Building the project
Buyer-Funded – is where the developer uses client funds for the build. This is designed to work extremely beneficial for both parties. It’s cheaper for the developer to pay interest to the investor (varies between 2% -7%)than a bridge-loan or other forms of borrowing. The deposit monies are paid by the purchaser and held in the solicitor client account/Escrow; when a build-milestone has had official sign-off from the project cost management team, QS or architect the monies are released in tranches for that project exclusively.
Some projects will have a tangible stage payment during the build e.g: Roof Level. By this time the developer has given the investor confidence but requires another influx of monies to cash-flow the project to completion. This stage payment amount once paid over to the developer will also earn the same level of interest p.a. as the exchange deposit. The interest will be accrued during build and deducted from the completion balance.
Bridge-Loan – this is a short-term loan used either until permanent financing has been obtained or money has been earned from profit e.g: completion of a project. The loans are up to one year and are high interest -however its immediate cash flow. The developer may use this type of lending either to buy the land initially -especially if the project is small and will be built within 12 months.To bridge the gap between starting construction and X number of sales off-plan. Or towards the end of the project, once buyer-lending has been spent on build and they need that last tranche of monies to bring it to fruition.
Contractor funded – if a developer works with a large contractor to build-out the project, the contractor may provide funding. It may be full funding or a percentage of the build, dependant on how the project cost management has been structured.
Development Finance – companies that specialise in residential and build loans only. A range of different types of finance to suit the developer: build to let, commercial; mezzanine.
Developer own-funds – while this may not be the most common way for a developer to finance a development – often there is not enough profit from one development to fund the entire next project – certainly a contribution of developer-funds could get into a project.
Peer-to-peer – is another investment model going on behind the scenes. Instead of the buyers funding the build, the developer will borrow from a company who have attracted “lenders” earning a fix term intertest paid monthly on the money they lend. The developer backs this borrowing with a tangible asset e.g.: land, property, personal and agrees a term the money will be returned (3 month – 5 years) in a developer’s case, it’ll be just after the completion of the development.
Combination – with a brief overview of the most common developer lending and funding options, it is often the case there will be a combination of two of the above e.g.: Buyer-funded and contractor funding or bridge loan and Buyer-funded. At the very least the developer will have a contingency back-up plan of access to more funds if required, to either get the project out of the ground on time or completed on time.