The Capital Stack is best described graphically as a “tower” detailing the specific types of capital/finance invested into a particular project. These tiers portray the different levels of risk involved as a direct consequence to the subsequent level of potential returns gained. It is a hierarchy of creditors listed in ascending order under the hypothetical, but very possible situation of a loan defaulting. We can normally divide it into these four main categories;
The most important points to remember to understand how the Capital Stack works are that each level has seniority over all the capital sources located above it in the stack. Conversely, each capital source is subordinate to all the other levels located below it.
Development finance is similar to Bridging finance in respect to the short term and interest only nature of both solutions, however Development lending is based on the projects final Gross Development Value (GDV), that is the capital value of the completed project when sold to a willing purchaser on the open market. With that in mind it allows for lending on a much larger scale and should the development increase in value as the project progresses further funds may be released, allowing up to 100% of the construction costs.
What does this financing cover? New build? Conversion? Renovation? Part-build? Property development finance is funding for either major new building projects or comprehensive renovations. We can source finance for residential, commercial and mixed-use developments. We’ve spent the last 25 years’ helping experienced and new property developers find the finance they need to start and finish their projects.
Property development finance is not usually used for smaller scale developments like the ones you often see on TV where developers improve a house or flat then sell it on for a profit. Generally this type of work is funded by refurbishment finance or a bridging loan. And we can help with that too. How much can you borrow?
The loan amount is based on a percentage of the gross development value (GDV) at the end of the work, currently up to a maximum of 60% loan to GDV, with a maximum of 75% of the total costs. Typically we work with developers looking for funding from as little as £250k through to projects needing finance in excess of £25m. There really isn’t an upper limit but if you want to borrow a smaller amount, a refurbishment loan is likely to be more suitable.
Loans are normally structured to ensure that the developer’s contribution is utilised up front with the lender providing the majority, if not all of the build costs. It is usual for funds to be drawn down in stages against architect’s or quantity surveyor’s certificate.
Traditional banks, Loan to Cost to 65-70% and to 60-70% GDV.
The stretch also allows developers to spread their equity across a greater number of projects.
We have stretched debt funders who will consider funding from £500k to £100mn.
Loan to Costs is 90% with the lending being no higher than 75% of gross development value.
Loans are blended funding via 80% senior facility plus a 10% internal mezzanine “type structured” facility
Loans from £500k to £10 million, larger considered
Loan terms typically 12 to 30 months. n Rates depend on LTV typically 5.75% + BBR – 9% pa (all in) at 60-65% of GDV n Rates at 50% Loan to GDV or less 4.75% + BBR
Each application is assessed and negotiated on its individual merits but the following general criteria will apply:
Projects located in England, Scotland and Wales in areas with strong demand
Projects must have planning in place
No restriction on the number of units
Loans 100% secured on the development property.
Must be a house builder with demonstrable track record.
Mezzanine finance provides a second layer of debt funding to fill the gap between the level of senior debt (which would typically be provided by a bank or fund) and the developer’s/sponsors own equity investment into a property development transaction. It is typically secured via a second charge. Typically a senior debt lender & mezzanine (junior debt) provider will execute an Inter-Creditor Deed (ICD) to reflect their legal position within the capital stack. A mezzanine lender will normally be required to fully subordinate to a second position although there maybe negotiations on various clauses.
Lenders provide up to 75% of GDV (with no cap on costs) as second charge mezzanine property development funding from 14% pa (80% of costs) and 17% (90% of costs) with ins and outs set at a level so as to ensure the cost is the cheapest for that particular project in the market.
Flexible regarding the size of the loans; we are able to provide mezzanine debt facilities ranging from 100k up to 10m.
Loans can be non-compounding (simple interest), which makes a huge difference in cost. Due to the reduction in senior lending in recent years, utilising mezzanine finance has become very popular and is routinely used in conjunction with senior debt. This type of finance is secured by way of a second charge and means a developer can minimize his contribution to just 5-10% of project costs. This will also significantly increase returns on equity invested by developers.
Equity financing typically refers to the provision of capital through the sale of shares in a development project.
Equity is a product that we offer that comes from external sources both individual and institutional
Equity requirements for specific projects of over £500,000 the equity itself comes from a discreet set of High Net Worth individuals, London and Globally based Family Offices and Private Equity Institutions to provide bespoke joint venture and equity finance for property developers and investors through the UK and parts of Europe.
Flexible with our approach and can offer assistance to those with single or multi-unit projects – we are perfectly flexible with size. If the project is strong enough, we are equally happy looking at 500k, as we are 25m, equity tickets
Typically equity financing can be provided between 50-90% of the required equity amount. The “Developer” or project proposer must be able to contribute “skin in the game” anywhere between 10-20% of the project cost. Senior debt providers will ask why the developer chooses not to support their own development project if there are seeking 100% finance.
Returns can vary from 20-25% IRR or 1.3-1.5 X amount invested and in addition a “hurdle rate” of 10-12% pa charged. Profit share typically if 90% of the equity provided typically will be 50%/50%. There is a JV agreement which will outline the returns and repayment structure often referred to as waterfall arrangement.
Return of Funds: (Known as “Waterfall” arrangement)
First, A pro rata return of initial equity contributions to the parties – i.e. 90/10
Second, A return of equity, the investor will be paid a “Priority Return” of an amount reflecting yield of 10% pa, or the duration of the development, on equity invested by the investor (Priority Return)
Third, After PR – “Catch Up” to the developer of an amount reflecting a yield of 10% pa for the duration of the development, on capital invested by the developer (Catch Up)
Fourth, The balance of profit distributed in the ratio up to an agreed limit (estimated profit in financial analysis) 50/50.
Thereafter any remaining balance of profits resulting from the development above the limit agreed in (D) will be divided between the parties in the ratio 70/30 in favour of the developer. The JV agreement will cover also:
Having covered the lower “debt” levels of the Capital Stack, this brings us to the upper “equity” investments layers. As we have established, risk is significantly higher as equity holders are the owners of stocks and shares in the Special Purpose Vehicle (SPV), set up by the borrower. In addition, unlike with debt investors (Senior and Mezzanine) who are usually paid a fixed interest rate, returns to equity investors come from the profit generate by the SPV. Because of this, you will only be repaid after the company has met its obligations to its lenders. Equity investments can offer the investors higher projected returns because of the risk involved, but this is deemed to be worthwhile by many property investors as the returns specifically depend on the profits made by the company. Sometimes returns will be more than initially projected and sometimes they will be less appealing to those property investors with a bigger appetite for risk.
Most Senior Debt Providers like to see at lease 10-20% of the equity directly provided by the sponsor. “Skin in the Game” sits well with the lenders and shows the developer is prepared to commit funds to a known project and will be focused on the project to deliver the scheme and targeted profit. 80/90% is then provided by the Equity Investor.
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