While property development can be a very profitable pursuit, many developers find themselves limited by poor cash flow. That’s because the nature of property development dictates that cash flow events occur in large single events, when a property sells, rather than through consistent, smaller returns, as is the case with most businesses.
In this article, we will introduce what development exit finance is, how it can be used to improve cash flow for developers, the pros and cons of doing so and the alternatives available.
What is development exit finance?
Development exit finance is a type of bridging loan that is used to repay development finance as a property development project nears completion, usually raising additional capital for the developer.
Lenders are usually happy to offer development exit finance once a property is wind and watertight. While this is a general rule, some lenders are happy to offer development exit finance earlier than this, and others will only lend once practical completion sign-off has been achieved.
This type of finance is commonly used for two main reasons:-
1. To release equity back to the developer, which can either be used to manage any cost overruns on the project or to fund the acquisition of the next project.
2. To allow the developer to extend the term remaining on the existing development finance facility, ensuring there is sufficient time to secure a premium price for the completed units.
3. As the interest rates charged on development exit finance is lower than those offered by development finance lenders, it is often used to reduce interest charges.
How does it work?
A development exit loan is arranged over a set term, often between 6-12 months, with the interest rolled into the loan. This means there are no monthly payments to make.
As the properties sell, a portion of the loan is repaid from each sale, reducing the loan by either 100% of the net sale price, or the agreed loan to value (LTV) ratio. The level of repayment is usually agreed upon upfront, although it can be renegotiated on occasion should things change.
While interest is usually set aside for the whole term, it is usually rebated to the borrower in the event of sales coming in before the term end.
What does it cost?
Rates start from 0.4% per month and are usually between 0.4-0.75%. The rate charged depends on the security type, location, current build state and the loan to value requested. Applications that are wind and watertight and at a low LTV will usually receive the best interest rates.
In addition to the interest charged, lenders usually charge an arrangement fee for arranging development exit finance. This usually costs 1-2% of the loan and must be factored in.
How can it be used to improve cash flow for developers?
In simple terms, development exit finance allows developers to save money on their finance costs and release cash from a project before it sells. This allows the developer to ‘keep the wheels turning’ rather than having to wait for a large, single cash flow event.
While many development finance lenders allow borrowers to finance up to a maximum of 55-65% of the end value of the scheme, development exit lenders offer between 75-80%. This additional money can be the difference between being able to secure the next project, or missing out while waiting for their completed units to sell.
What are the pros and cons?
While development exit finance can be a great help to property developers, as with everything, there are pros and cons to consider.
· Development exit finance is great for cash flow.
· It’s cheaper than property development finance, saving you money.
· It allows you to take your time when selling your completed stock, potentially leading to you securing a better price.
· It can lead to increased profits by allowing you to move on to your next project quicker.
· While it’s cheaper than property development finance, there are still costs involved.
· There is an application process that, while simple, still takes up some of your time.