STRUCTURING A LAND PURCHASE WITH FUNDING IN MIND
Most property developments start with the land purchase. Developers should have an idea of what could be achieved from the build out and should therefore have an idea of what will be needed via funding.
As a very general guide (but changes all the time due to the market) an experienced developer may be able to obtain 50% of the land purchase price and 100% of the build out cost subject to the loan amount being within the criteria of the chosen lender. In other words the loan as a percentage of the end product aggregate sale price or GDV (Gross Development Value) not being too high as the higher this percentage the less lenders criteria it fits.
Therefore you may be able to structure the deal without having to put in your own money up front, you can pay from the profits at the end.
If you have the right scheme and it’s viable for lending you may want to structure the land purchase with the vendor to avoid putting any cash into the deal. You can do this by negotiating options on the land purchase. It is very common for developers to buy land subject to planning, because the land only has value if planning is granted and provided there are no onerous conditions to meet. There are different types of options which lenders are happy to work with:
- Deferred payment.
This means you defer an amount, ideally 50% or more of the land purchase price to a future date or event to trigger the payment for the land. For example deferred payment for 12 months or when the plots have been built or when the plots have been built and sold.
If you can negotiate this structure it means the 50% of the land purchase price the lender wants you to put in at the start is deferred until after the build at which point you can pay for the land from the profit.
Please note that lenders will work on a deferred payment basis but will require that the structure agrees to the lender being paid for their development funding before the vendor is paid for the land. This is simply to avoid the lender being forced to pay the deferred payment or losing the land and they don’t want to be in that position. If you are negotiating a deferred land payment its best to avoid a ‘bullet payment’ at a future date say 12 or 18 months after the start of the agreement. The bullet payment simply means you to pay on a certain date, irrespective of the build stage and now there is a risk that the development performance could jeopardise the land purchase which is unacceptable to the lender funding the scheme.
- Vendor Venture.
V V is a not an industry term but the term I use to describe the instance where the vendor becomes involved in the development using the land as their collateral. Let’s say you have a land purchase of £100k and you can build 2 pairs of semi-detached houses – 4 houses in total. A very rough build out cost of £400k and a GDV of £1M being £250k per house. 9 month build schedule and 3 month sales schedule so 12 month start to end. This is a good development opportunity and the vendor could get a piece of the action by donating the land as their part of the deal and then getting a profit share at the end. The profit share could be with or without a deferred land element for example:
- Vendor defers 100% of land price (£100K) until plots sold and then gets £150k, so makes an additional £50k
- Vendor provides land at zero cost takes a 33% net profit share at the end. Based on the example above net profit after interests and all costs will probably be roughly £450k so 33% will be £150k
The bottom line is that you can do this development with no money down but it will cost you £50k of profit and that is cash not in your bank that otherwise would be.
As developers complete more schemes and gain more experience they generate equity in their business which enables them to buy the land in whole or part upfront and avoid sharing the profit from their endeavours. In addition more schemes leads to economies of scale with lower build out costs and higher profits. It is not unusual for developers to be caught in a vacuum when they begin their developer journey. By that I mean that they are often trapped into taking out expensive development finance and borrowing more than they need to purchase the land. Our aim is to help developers retain more profit from their development schemes which, in turn, enables them to move up the funding ladder, access cheaper finance and retain even more profit.
At Specialist Property Finance its our role to help and advise the developer navigate through the funding minefield to avoid declines because the terms of the options don’t fit and help the developer obtain the best funding terms and rates to enable them to prosper.
In the next blog of this series I will be discussing funding a development during the build out stages.