COMMERCIAL BRIDGING LOANS AND MORTGAGES

As an alternative to property development loans you may be able to raise funds more flexibly by the use of normal commercial loans, particularly bridging loans, against the specific site being purchased or by commercial mortgages, for example against an existing portfolio of properties.

Bridging

Bridging loans are short-term loans, typically of six to 12 months length with a three month minimum period, secured against property.

• They are generally quick to put in place, taking a week or two if all goes well, and do not tie you in long-term to a particular funder.
• They can usually provide funds of up to 70% of the property value (or even higher using some top-up funders).
• They can be open or closed where arrangements to repay the borrowing are in place from the outset.

• They are generally non-status where the borrower is simply operating on a pawn broking basis, in that if the borrower defaults, the lender can recover their money simply by a sale of the property.
• They tend to be based on the property’s value and not simply its purchase price.

Mainstream banks will offer closed bridges on a status basis. For open bridges and non-status loans there are a limited number of serious players in the commercial property bridging market, mainly lending up to £2m. Larger bridging loans can be arranged, but this is an area where specialist advice is required in syndicating and placing the proposal.

Bridging loans are, however, expensive. As well as valuation, broker and legal costs, you can expect to pay a lender’s arrangement fee of 2% to 3% and discounted interest rates currently of between 1.25% and 2.5% per month. Interest is either collected upfront by way of a deduction of the total interest charge for the facility period from the initial drawdown, or monthly or weekly in advance, or more rarely rolled up into a bullet payment at the end of the arrangement. So you should always be looking from the outset at how you are intending to repay the bridge, either by selling the asset on or refinancing it (known as takeout finance). In the event that you default you will lose the right to pay the discounted rates of interest which can lead to charges accruing at up to 5% per month and lenders will take swift recovery action. You should never go into a bridge without having both your exit and your interest servicing planned and, if anyone you are dealing with appears to be advising you to take out a bridge without having both this and the funding of the ongoing interest charges covered, you should seek another adviser immediately.

Against this being interest only, bridging loans can in some circumstances have short-term cashflow advantages over a normal commercial mortgage where regular payments would include an element of loan capital.

However, bridging is also an area fraught with risks. It is therefore vital to deal with reputable funders to avoid the following.

• Predatory lenders, by which I mean lenders who may have another agenda such as an interest in acquiring properties for their own portfolio, or unfair terms such as excessive repayment penalties, or the ability to impose changes in their terms at short notice, or hidden charges.
• Advance fee fraudsters who will take an upfront fee to arrange financing, together with collecting cash to arrange valuations and, sometimes, even a monthly retainer until such time as they manage to raise finance but never deliver the funding promised. While the cash paid out to this type of fraudster is bad enough, things can get even more serious when the victim then goes ahead with a transaction based on the understanding that they have finance in place when this is not the case, leading to situations for example where:
  • an individual put down a multi-million pound deposit on the purchase of a commercial development property based on an offer of funding, but was then unable to complete and not only lost his deposit but was also facing an action for costs and interest from the vendor; and
  • an individual who had completed on the purchase of a development property using a bridging loan at high rates of interest; and who then thought that they had arranged replacement finance, only to find that when they went to sign the completion papers for the loan they were dealing with an empty accommodation address and rates of default interest of up to 5% per month.

A finance broker such as Creative Business Finance Ltd will charge you for arranging a facility, typically based on:

• 1 % of the sum borrowed;
• a success fee only basis on your acceptance of a sanctioned offer (and not simply an offer in principle which does not actually commit the lender to lending to you); which is
• deducted from the advance drawn down.

Using an asset finance broker can assist you in raising all types of property development finance, but you do need to be careful to find and use a reputable broker in whom you can have confidence that they will look after your interests and you do not find yourself in the types of situations below.

• A broker arranged a multi-million pound bridging loan for a client to buy a development property (and took their fee for doing so), but failed to arrange for either the interest to be rolled up until the bridging loan was repaid or development funding put in place to service the interest, leaving the client in immediate default and facing a bankruptcy petition.
• A client found a development site and spoke to a broker to arrange financing, but it appears that the broker brought in his own property investor and bought the site to undertake the development themselves instead.

The National Association of Commercial Finance Brokers (NACFB) is the trade body for asset finance brokers and was set up in the first instance to tackle the issue of advance fee fraud. Any reputable brokerage should therefore be a member and a list of members can be found on their website www.nacfb.org.

Uses of bridging

So if bridging loans are such a risky area, why might you consider using them?

They can enable you to move quickly to secure the purchase of a site where it would take longer to get financing in place for the full project.

Smart use of bridging lending’s property value based approach, combined with clever structuring of deals, can also allow developers to achieve almost 100% funding levels for projects, including the site purchase price. Two examples show how this can be done.

• A developer with an option to buy an old approved school site wanted to fund its purchase and development. Having obtained planning permission for the project that increased the site’s value over the purchase price, the developer was able to take out a bridging loan against the site’s current value which provided sufficient funds to both complete the purchase and to complete the refurbishment of the first few units. They could then go on to sell these units to repay the bridging loan and use a series of rolling bridges to fund the subsequent phases of the build out, without having to put up any equity other than the small initial option payment.
• Another developer purchased a site using a conditional sale dependent on obtaining a change of use from the existing office use. Once planning was granted, again they were able to borrow against the uplifted site value to raise sufficient funds to complete the purchase and start development. As a result, the client needed to put up no equity other than the initial option payment, which meant that by using syndicated loans they obtained over 99% debt funding of a £15m project.

The key information that a bridging lender will require is relatively simple, as set out on the bridging enquiry form shown in Chapter 8.

Borrowing against a property portfolio

You may of course already have a portfolio of properties either from previous developments or bought as investments that you let out. When these have been acquired over the years you may well have a mix of different lenders in place. While this is a good way to manage all risk exposure to any one lender it has the disadvantage that you are unlikely to be maximising your capacity to borrow against these properties as a whole in order to fund further deals.

By consolidating all your borrowings with a single lender you can therefore take advantage of your equity across all your holdings in order to achieve borrowings of up to 85% of the entire portfolio’s value. In fact some lenders will on this basis provide you with a free, underwritten agreed facility to allow you to make further purchases. This type of approach can cover unlimited numbers of properties, including portfolios of over £5m with up to 25-year terms and three-year fixed rates available.

Lending is usually based on both:

• property value; and
• rental cover where a ratio of loan repayments to rent: 125% seems to be the current industry average.

Assessing the scope for raising this type of portfolio finance therefore requires reviewing the makeup of the portfolio, residential or commercial, its value, and its rental income as set out in the portfolio funding equity form included in Chapter 8.

TOP-UP FUNDING

The mainstream specialist property development solutions discussed above involve borrowing a percentage of the site’s value. This means that unless you are able to avoid this by way of a bridging solution as discussed above, there will be some gap between the sums that can be raised and the finance required to undertake the scheme, which will need to be met from some other source as illustrated below.

This can obviously come from your own funds, but if you do not have sufficient you will need to turn to an external provider for this top-up funding.

This requirement has traditionally meant entering into a joint venture with an equity partner on a profit share arrangement, but there are now also some specialist lenders coming to the market who are able to offer top slice loans as an alternative.

Equity funding joint ventures

These external partners will all generally operate on the basis of agreeing a profit share in the completed development, which as a rule usually starts at 50%. One issue to be aware of here is in defining the profit on the project, or more precisely, defining the costs that will be taken into account when calculating the profit. The equity providers will usually, for example, seek to insist that only the direct costs attributable to the project are included. This will exclude any recovery of your general business overheads which will have to come out of your profit share.

The funder will need a separate valuation addressed to them from a firm of their choosing and will expect you to bear this cost.

They will also generally want the scheme to be reasonably fully leveraged, so that the amount of equity required is kept to a minimum. In some cases they may wish to provide the debt funding themselves and charge a margin on this.

They may also provide a funding line against cost overruns, but this will usually be on bridging finance style interest rates.

And finally, to protect themselves, the equity providers may also seek the right to step in and take over the build to complete it if it is not going to plan. These rights could obviously be open to abuse so the developer needs to ensure they are carefully drawn.

Institutional funding

The institutions involved in such cases can include local building societies which will set up off balance sheet joint venture projects to develop sites, but these will usually be limited to their local area, while the merchant banks are sometimes involved in larger transactions. There are also some specialist property funds who will fund equity requirements of £250,000 to £500,000.

Where a project is larger than a particular funder wishes to undertake on their own, the project may be syndicated into a club deal across a number of investors. As with many areas of finance it is a case of knowing who to talk to or finding a broker who does.

Individual funding

The alternative to institutional funding is finance provided by high net worth individuals. Here the market is quite fragmented and it is difficult to contact such individuals. Instead, developers are generally dealing with an arranger who has (or claims to have) put together a network of wealthy individuals (their investors).

This leads to problems in establishing the bona fides of an arranger and their purported investors which, even with good references, can remain uncertain right up until the point when a transaction has been concluded.

This is another area where advance fee fraud can occur so any request for upfront fees should be considered very carefully. While a request from an individual arranger for an initial fees of £15,000 plus a retainer might put you on guard, particularly where there is a refusal to provide much evidence of a track record or references, some quite reputable networks charge a significant commitment fee to ensure that enquirers are serious before putting proposals to their investors. In these cases it is a matter of taking advice and attempting to take whatever references are available.

An exception to this can be a request for say £1,500 as a deposit, as an upfront fee of this level can often be being used by the funder to cover their initial legal fees in the event that the transaction does not proceed.

However, even if bona fide, the arranger themselves may well have difficulty in tying their investors down to a decision, or even to committing to a timescale within which to make a decision. The investors will often be busy, sometimes travelling extensively, and this practical issue can lead to significant delays and uncertainty.

Since the investors are funding each transaction with their own cash, they can also tend to be very choosy about which investments they will fund, again leading to uncertainty right up to the point of completion.

Top-up and mezzanine debt funding

The obvious disadvantage of equity funding is that you will end up giving away normally at least half of your profits to an equity partner.

As an alternative there are, however, some specialist lenders who can introduce funds on a debt basis which you may be able to use to eliminate the requirement for an equity partner.

One source, for example, offers a second charge top-up facility of loans from £250,000 to £750,000. These can be used to top up the level of funding that can be raised for the purchase of a site purchase through normal development funding of say 60%, so that you can actually borrow 90% of the site value and only need to find 10% yourself. You can then use the normal development funding of 100% of costs to complete the build out.

Another source is currently offering a similar facility which can provide a top-up to give up to 98% funding of the entire development project, including interest in professional fees.

This type of top-up facility is expensive as the lenders are stepping in to what would otherwise be an equity risk and therefore interest rates can run at 3% to 4% per month, although some lenders will be prepared to take this as a bullet payment at completion of the project. And of course you will need to be careful as to whether this is compounding or not, as a monthly interest rate of 4% will compound over a year to a rate of 60% (4% in month one and then interest on the principal plus the 4% interest in month two and so on), not simply 48% (4% times 12 months).

However, despite this cost, this type of borrowing can still be attractive compared with an equity investor, as illustrated below taking the example already used and assuming a one-year project:

JOINT VENTURES WITH DEVELOPERS FOR OWNER OCCUPIERS

In some cases an owner occupier will hold a property which has development potential, but does not have the capacity or skills in-house to develop the site themselves.

These situations can be resolved by entering into a joint venture with a developer. So for example, a company operating from a large industrial site at the edge of town, with excess capacity, badly laid out buildings that had evolved over time and surrounding spare land had decided that:

• it wished to relocate to smaller purpose built premises;
• it did not have the expertise in-house to manage a property development project; but it recognised that
• the site might be of interest for a major retail development provided that the planning issues could be dealt with.

The solution to this problem was a joint venture with a developer under which the developer sought the necessary planning permissions. Once these were obtained the developer would then:

• build an alternative site for the company on a new site to be let to it on a normal institutional lease; while
• the developer then developed the original site, with the company having a share in the profit.

Each such arrangement will need to be tailored to the precise circumstances of the site and business involved.

SELF-BUILD DEVELOPMENT LOANS FOR OWNER OCCUPIERS

Finally if you are considering a self-build project for your own use as an owner occupier (or in some cases to retain for letting) there is a range of mortgages designed to meet your requirements.

These will typically involve a commercial mortgage of up to £5m taken over from five to 25 years at interest rates close to normal commercial lending terms, plus a lender’s arrangement fee.

In other respects these loans are much like normal development finance in that they will lend:

• up to 70%-75% of the final value and occasionally more in respect of commercial units; with
• money released at stages as agreed, based on valuation certificates, which in some cases during the build phase can mean that funds are available at up to 90% of the current valuation.

RAISING PROPERTY DEVELOPMENT FINANCE

For a successful property development you obviously need to have the right:

• site;
• plan as to what you are going to create; and
• process for controlling and completing the build.

To this list I would add a fourth factor: funding.

Given the scale of finance involved in most property development transactions, successful funding arrangements are usually a critical element that can play a major role in helping determine the success or failure of the project. So in seeking whatever sort of funding for your project, there a number of general guidelines that you should bear the following points in mind.

• Undertake contingency planning for any problems with your planned funding. By doing so you can ensure you have a strategy for dealing with the worst case scenario that you can put into place if needed (such as when the developer exchanged contracts to buy the site only to find that their equity investor then failed to complete on their £750,000 investment in the project).
• Know who you are dealing with. By which I mean that if you are going to rely on someone to organise finance for you, you should check to ensure that they have the expertise to put in place what you need them to arrange. In one case a developer needed to raise a bridging loan within a tight timescale to complete a purchase, or risked losing a multi-million pound deposit. Unfortunately the broker they had instructed had little experience of raising such specialist loans and failed to take the steps required in speaking to the appropriate lenders in order to do so.
• Ensure you understand the risks involved in any arrangement, such as those outlined above in any bridging loan, that you are entering into.
• Look to add value to your project by the work that your brokers do and the financing options that you choose, which should be the most appropriate ones for your venture and not simply the cheapest.

A developer had built a block of flats as an investment property to be retained and let and simply wanted to replace the development finance with cheaper buy to let mortgages. In arranging the borrowing the broker advised him to restructure the property holding from a single building into individual long leasehold flats. The results were these.

• The value of the property went up by 20% – as a single property this building could only realistically be marketed to other property investors. By creating individual leasehold properties these could be sold on the normal open market, increasing the total value.
• The level of funding available increased and the cost of borrowing went down – an individual institution looking to lend against the block as a whole would be concerned about concentration of their exposure to the number of flats in one location. This would lead to caution in the loan to value offered and an element of risk premium in the rate. By being able to spread the lending amongst a number of the retail buy to let providers against individual flats, the client could obtain normal high street rates and terms.
• The flexibility of the arrangement was improved – as now there were individual leaseholds the owner could realise these piecemeal as required, rather than having to dispose of the entire block in one transaction, thereby reducing some of the risk.