Frazer Fearnhead, founder and chief executive of The House Crowd, explains the benefits of property development finance for retail investors
SINCE THE CRASH IN 2008, banks have been restricted in what they can lend to developers and this has created opportunities for retail investors, by providing finance to small- and medium-sized enterprise developers via peer-to-peer property lending platforms.
Investors can now pool resources and lend small amounts to credible developers with a proven track record. Platforms offer a range of opportunities to provide senior debt, junior debt and mezzanine finance. The risks and returns increase according to which part of the ‘capital stack’ you are financing. Senior debt tranches of up to 60 per cent Loan to Gross Development Value (LTGDV) will usually pay six to eight per cent per annum, junior debt will typically pay 10 per cent and mezzanine lenders, who take the biggest risk on the project exiting successfully, can achieve 13 per cent per annum or more.
Lending against a property development has two huge advantages over investing on an equity basis. Firstly, your interest is protected by a legal charge and, secondly, you get paid out first. So, should the properties not sell for the forecast prices, the developer and his equity investors are in a first loss position, followed by mezzanine finance lenders and so on. Therefore, you can lend up to a LTGDV that you feel comfortable with and earn a commensurate reward.
The basic property development formula is quite simple. The developer buys or gets an option on land, acquires planning permission, hires a contractor to build and then sells. However, in reality developing is very complicated and fraught with burdensome regulations, as well as unexpected delays caused by planning departments, utility companies, newts, bats and the weather to name just a few. Furthermore, there is never any guarantee of how quickly the developer will be able to sell the houses to repay you.
The good news is that whilst nothing is certain, you can mitigate your risk by carefully selecting which development to invest in. Here are the key points to look for:
- To avoid long delays, invest only when full planning permission is in place.
- Ensure a professional feasibility study has been done and there is a profit margin of 20 per cent on gross development value to allow for a drop in the market.
- Don’t just invest at the highest rate which carries the most risk.
- Ensure the developer has a strong track record for developments of that type and size and knows the market well.
- Ensure the chosen contractor has a healthy balance sheet and is hired on a fixed price design and build contract so they carry the risk of any overspend or delays (subject to things beyond their control).
- Consider how attractive the development is – the houses must sell for you to get your money back.
- Make sure there is an experienced new build sales and marketing team in place and that there are a high number of comparable new build sales in the area.
Alternatively, if you like an easier life, on a platform like ours, you can select an auto-invest product or Innovative Finance ISA, according to your appetite for risk. We will then diversify your money over several developments and pay you regular interest.
To learn more, click here to watch an interview with our development director Justin Molloy.