Commercial lenders are specialists. Some lenders have a direct-to-developer model, but many rely on a network of commercial finance brokers to bring them business. And here lies yet more good news – these commercial brokers are on your side. Their job is to find a lender who can fund your project.
Transparency is critical, and your broker will need to know all about the deal and your professional team, as well as you and your development business. If you have a few financial skeletons in your cupboard, tell your broker. It invariably comes out in the wash anyway, and you risk alienating everyone involved if you ‘forget’ to mention your unmentionables. Armed with the truth, your broker can then go out hunting on your behalf to find you the funding. How many brokers do you need? There’s no harm in having two or three on speed dial, as they won’t all be tapping into the same sources.
Here is how it works. Let’s say you have your eye on an old commercial building that you want to transform into four new apartments. It will cost £200,000 to buy the building and a further £300,000 to develop the four flats: the total required is £500,000.
A commercial lender will typically lend 100% of the development costs. This development finance covers all costs associated with the project. It includes the fees for your team of professionals, the finance costs (interest will be rolled up and paid at the end of the project), and of course, all the materials that will be delivered to the site.
Your commercial lender will also provide up to 70% of the £200,000 asset purchase price, which leaves you to find the remaining £60,000. And this is where private investors come into play.
Private investors are individuals who have savings or capital to invest and who are looking for a reasonable return. Now, unlike your architect or your contractor, you can’t look private investors up in the phone book and ring a few of them up. You’ll first need to find them yourself and then convince them to invest with you. If that sounds challenging, there’s more good news. Almost anyone could be a potential private investor. Friends, relatives, and colleagues can often be a rich seam to tap into because they already know you and (presumably) trust you.
You may think that none of your friends or family has that sort of money. But you’re likely mistaken. They won’t advertise the fact, because usually people are pretty private when it comes to their finances. Yet people have savings, and people have pension lump sums. But in this day and age, the one thing they don’t usually have is an excellent rate of return for their money. The same goes for people you network with or encounter in everyday life. There are potential private investors at every turn.
So, what can you offer them? Most private investors can expect to receive an 8% to 10% annual return in property development. It’s not bad, is it? Particularly when the same money will earn them less than 1% in the bank. And while their loans won’t be secured on the property you’re developing (the commercial lender will take a first charge), the fact that the underlying asset is bricks and mortar rather than stocks and shares is a big plus, security-wise. And, of course, you don’t need to try to find just one investor; you could instead find six investors who are willing to lend you smaller amounts individually.
While it’s possible to use other people’s money exclusively, it’s certainly not the easiest route. These days most commercial lenders will want you to have some skin in the game as the developer. Sure, the lion’s share of the deposit can come from private investors, but you should still be prepared to stump up some of the cash yourself, and each lender will have different requirements in that respect.
One thing you must not lose sight of is that money lending is a heavily regulated business, and there are some key ‘dos and don’ts’ when looking for and approaching private investors. Be sure to check out the FCA’s rules on the subject.
Property development is a business where there’s invariably more than a few bobs at stake for everyone involved. For both commercial lenders and private investors, you’ll need to inspire confidence. How serious are you? And how knowledgeable? Do you have a business plan and a team that ticks all the right boxes? Do you understand your deal inside and out? The word that crops up in each case is ‘you.’ But it shouldn’t just be all about you. You need to have a brand behind you. A name, a logo, a website, and a business card. People need to feel that they’re doing business with a brand and not just an individual, no matter how firm your handshake or how convincing your smile. So make sure you set these things up right at the start. The number of private investors who didn’t try to check out the developer’s website before they agreed to lend them money is probably as near to zero as makes no difference.
Finally, cast your net far and wide. Commercial lenders are traditionally Route One when it comes to finding finance, but they’re not the only game in town.
One of the more recent kids-on-the-block is peer-to-peer lending, aka ‘crowdfunding.’ The premise is simple. The peer-to-peer lender secures funds from lots of different private investors on the one hand, and then they arrange for the money to be lent to developers on the other, taking a fee in the process. Like the commercial lenders, they’re adept at critiquing deals, which means their lenders can have confidence that only good developers with decent deals will be put forward. But they can also offer advantages to developers over and above the traditional lending route, so it’s well worth doing your research.
You’ll also find many investment clubs and groups out there as well as a range of high-net-worth ‘angel investors.’
Remember that there is a lot more money out there that needs investing than there are property deals that return 8-10%. So don’t forget that it’s the developer that has the whip hand when it comes to finding investors, and not the other way around.
*Ritchie Clapson CEngMIStructE is Director of propertyCEO