Development finance has experienced impressive growth over the past decade or so, but to many the term may still be unclear. Put simply, it is a form of alternative finance — a lending mechanism that sits outside the channels of traditional finance institutions — that is used by property developers to fund construction projects, like new-build properties.
For property developers, there are a number of boxes that need ticking when acquiring a new funding stream. Unlike high street banks, property development finance can be arranged quickly, with each individual application for a loan assessed on its own merits. Providers who arrange development finance also offer a higher loan to gross development value rate over mainstream lenders. For investors – those responsible for loaning their capital – there is the benefit of potentially offering significant returns, particularly in this current low-interest rate environment.
There are several reasons that explain why property development finance has burgeoned over the past decade or so. Successive UK governments have been blighted by the housing crisis, leading to a surge in demand for property across the country. In turn, this is putting pressure on construction firms nationwide — making the need for efficient property finance all the more significant over the coming 12 months.
Could history repeat itself?
The rise of property development finance, and indeed alternative finance more generally, came as a result of 2008 financial crisis. In the immediate aftermath of the economic downturn, banks became much more risk averse, tightening their loan criteria and making it more complicated for consumers and businesses alike to acquire a loan. For the many businesses that were responsible and always abided to the necessary due diligence procedures, this posed frustrating challenges.
But they still needed credit from somewhere, leading to the precipitation of second-level institutions known as alternative finance lenders. Move forward to the present day and these alternative finance lenders are actively challenging the monopoly once held by the high street bank. And for construction companies in need of finance, there are significant advantages on offer when dealing when dealing with a development finance firm.
Looking to the coming 12 months, there are significant events on the horizon that will no doubt impact the financial markets, beginning with the UK’s withdrawal from the EU on 31st January in 2020. With this in mind, we could once again see traditional lenders once again adopting risk-averse practices, making it difficult for businesses to acquire finance. Thankfully, the alternative finance sector is adequately placed to meet future demand.
Addressing the complex needs of the real estate market
The housing crisis combined with low interest rates and established construction firms all provide favourable conditions for the development finance sector to continue to grow. What’s more, there are natural advantages for investors and construction firms alike when engaging with this form of alternative finance.
Property is a sector that is defined by difference, with all projects having their own merits, risks and opportunities. High street banks, which can be hampered by a structural lack of agility, are therefore particularly ill-suited to consider loan applications from construction firms.
On the other hand, there is an inherent personal touch when it comes to different avenues of alternative finance. Indeed, for those in need of development finance to fund a project, many take solace knowing they are dealing with a property development finance firm that is well-versed in construction projects. What’s more, property development companies can either raise all the capital needed for a project, or partner with a heritage or challenger bank if senior debt is required.
In sum, 2020 should be a positive year for the sector. Low-interest rates, intractable demand for new homes and a sense of economic uncertainty could combine to make favourable conditions for development finance and those who invest in it, helping to boost deserving projects and new developments. I now look keenly to see whether the government will take action to encourage funding by challenger banks and alternative finance.
Paul Howells, CEO of Accumulate Capital
Paul Howells is CEO of Accumulate Capital – an investment and property development firm. Accumulate Capital connects registered investors with developers in the property development finance sector to enable selected, high-yielding projects in the UK and overseas.