Sometimes we can hear jargon in an industry and not know what it means. More so, you may not want to ask a development finance professional, be they a lender, broker or other partner, for fear of not “knowing your onions”.
Below are some of the most commonly used phrases in the property development finance industry. These are not dictionary definitions but our take on what each means:
1. Types of Finance
Senior Debt or First Charge Lending – this type of lending is as you would understand a bank mortgage. A first charge over the site is taken and lending generally goes up to 60-65% of GDV.
Junior Debt, Mezzanine Finance or Second Charge Lending – this is where a second lender comes in to top up the amount borrowed. This finance is for the 10%-15% of GDV that isn’t funded by the Senior Debt lender, and typically has a ceiling of 75% of GDV. As a second charge holder, and in a more precarious legal position, ranking behind the first charge holder, the cost of funds is much more expensive, in the 1.5% to 2.5% per month range.
Senior Stretched Debt – this is where a lender has senior debt funds and mezzanine funds and has blended the two funds together to offer one product. This results in a mid market rate and a leverage of 70% to 75% of GDV.
Equity Finance – this finance is provided in place of the developer’s equity slice, which is usually considered to be 10% to 15% of total project costs (or 20% to 25% of the total project costs with banks and more conservative lenders).
Joint Venture Finance – a second form of equity finance, this is where 100% of the funds are typically provided by a joint venture partner in return for a generous profit share at the end (between 30% and 60% of the profits). Joint venture partners may provide their own funds, or in many cases go and source the senior debt themselves.
2. Loan Parameters
Net Loan/Net Advance – this is the amount a developer will actually receive
Gross Loan – this is the net loan, plus the interest and fees
GDV – this is the future retail sales value of the site, more commonly known as the Gross Development Value, or GDV.
Max. Loan to GDV % - this is the maximum funding a lender will provide against the GDV. Always note this is a Gross figure (i.e. includes interest and fees) and not the Net figure! The Loan to GDV and Loan to Cost ratios below need to both work in order to lend.
Max. Loan to Cost % - this is the maximum funding a lender will provide against the total project costs (excluding finance and disposal costs). The Loan to Cost and Loan to GDV ratio above need to both work in order to lend.
Day 1 LTV % - this is the calculation a lender will consider when the borrower is buying the site i.e. how much are they willing to give a borrower on Day 1.
Term – how long the loan will be.
Rolled Interest/Interest Roll up – for virtually every development finance lender, interest is not paid until the end via the sales of the properties.
Retained Interest – some lenders will retain the interest upfront from the loan rather than taking it at the end.
Serviced Interest – interest payments are made monthly in a similar fashion to a bank loan (if a developer wishes to do so and the lender allows).
Default rate – this is the increased rate of interest the borrower will pay if the site falls into default.
Drawn Balance – when the interest rate is applied to the amount of funding that has been used so far, rather than on the total facility from the start.
Compounding Interest – when interest is calculated on the principal and the accruing interest on the previous loan periods.
Non-compounding Interest – when interest is calculated on the principal only.
S-Curve Development Finance Calculator – this is a model used by some lenders to predict a developers cashflow, and therefore finance costs, throughout the build period.
Cumulative Development Finance Calculator – this is a model used by some lenders to project finance costs on a compounding basis.
IRR based Development Finance Calculator – this is a model used by some lenders who have an Internal Rate of Return to hit, and work back from that return % to come up with what they can lend.
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4. Paperwork (Application Stage)
Asset & Liability Statement – paperwork provided by the borrower to demonstrate net financial strength and the ability to support Capped Personal Guarantees.
Development Appraisal – a project summary provided by the developer at the application stage, breaking down the total project costs, sales values and profit margins.
Cashflow Schedule – a monthly breakdown on required funding for the project, and what activities the funding is required for.
Comparables – paperwork compiled from estate agents and internet sites to demonstrate evidence that the sales values of the units and the GDV are accurate
5. Paperwork (Legal Stage)
Conditions Precedent – these are conditions set out in the loan agreement that the developer must adhere to.
Legal Charge – the lender will take a legal position whereby in a repossessed state they can take sole control of the site and its disposal. Registered at HM Land Registry.
Debenture – a certificate acknowledging the lender’s debt and used as a further control mechanism.
Personal Guarantee (PG) – signed paperwork from the borrower agreeing that they can support a Capped Personal Guarantee, usually in the region of 20-25% of the loan amount. This is calculated based on owned property and land assets.
Collateral Warranty - is a contract under which a professional consultant (such as an architect, a building contractor or a sub-contractor), warrants to a third party (such as a funder) that it has complied with its professional appointment, building contract or sub-contract.
Professional Indemnity Insurance (PI Cover) - If a third party consultant or contractor are alleged to have provided inadequate advice, services or designs to a client, professional indemnity insurance provides cover for the legal costs and expenses in defending the claim, as well as compensation payable to the client to rectify the mistake.
New Homes Warranty – this is a 10-year insurance policy which protects buyers of new homes from structural defects.
JCT Contract – provided by the Joints Contracts Tribunal (JCT), the JCT Standard Building Contract is designed for large or complex construction projects where detailed contract provisions are needed. This is signed by the lead building contractor on site.
Appointment Letters – all contractors and third party consultants must be officially appointed, in order for the above paperwork to stand legally.
Permitted Development – this is the permisson to build without going through the full planning process. This mainly refers to the conversation of Office to Residential that has become a popular alternative to ground-up developing.
Cross-collateralisation - is a term used when the collateral for one loan is also used as collateral for another loan. This is possible with some lenders when sales are being achieved on the current project and enough equity is now available to part-service the next project.
Tranche – refers to a regularly provided portion of funding that may be “drawn down”.
Drawdown – this is either the moment the borrower receives the funds, or the contractors are paid directly.
Chris Davidson is Managing Director of Discover & Invest Ltd, a specialist development finance brokerage and operator of the Discover Development Finance website.
Chris believes in providing property developers with groundbreaking insights into the marketplace, that will allow developers to make better informed finance decisions, quickly, painlessly and cost effectively.
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