If you are planning on entering the world of property development, it is essential you have the necessary capital to get your project off the ground. Your available capital will be used to secure funding against purchasing land or property - but how much you have available can heavily impact your ability to develop.
In this article, we look at how you can maximise your available equity and make the most of it since the more equity you have, the more deals you can do, and the quicker your business will grow.
What is equity, and how much do you need in property development?
Strictly speaking, equity is the value of an asset less any debt, such as loans or mortgages against it. However, in the property development world, equity is also the cash a developer puts into a project (usually towards the land purchase) to buy and develop it.
Alternatively, equity could be value created (less any debt) by a planning uplift via a successful planning application. Most developments would require a development finance loan to make up the difference between the borrower's equity and the total project costs.
The deposit requirements vary hugely, and lenders can require significant amounts ranging anywhere from 10-40% of the project's cost, including land, building, finance and professional fees. On a £10 million project, for example, 10% is £1 million, whereas 40% would be £4 million - a significantly different amount that may be much harder to secure.
Where can I get more equity and leverage it more efficiently?
Even if you have little to no capital, there are still ways to secure property development finance. Although not having a significant deposit can complicate issues, there are still ways to secure funding to get your development off the ground and minimise your equity requirements.
- Consider a Joint Venture
A single source of funding is usually a bad idea. Instead, you should seek investment from a diversified pool so that you have less risk. Sometimes you can source some of your funding from non-conventional means such as friends and family or your professional network. These are more investments than loans and are, nonetheless, a great way to reduce your own equity burdens. They do take a larger portion of the profit through a high equity percentage demand but they also do not require you to pay the money if it is lost in the deal. So for giving away more upside, you give yourself downside protection.
- Use a Second Charge
If you have an existing property portfolio, some lenders will provide a second charge loan on investment properties to use equity from your portfolio as security for a loan. They are flexible and typically quick to issue - making them a great alternative to re-mortgaging or spending too much of your liquid cash. You need to make sure your portfolio is not leveraged at more than 75%LTV already, as that is usually where they cap out. Anything under that, and you can raise the capital quite comfortably to use as your equity in other deals. In some cases, you do not even need to withdraw the capital; simply cross-collaterisation can provide you with the funds you need. Alternatively, you can use mezzanine funding which sits on top of the 1st charge lender, to provide more leverage and lower your equity burden.
- Obtain Planning Permission
Planning permission can add value to land. If you purchase a site to secure planning permission, you can add value during the planning process. Some lenders will recognise this as soft equity and consider it when assessing your application and providing an offer. If you secure private equity for a land purchase before securing planning, you can avoid paying the high-profit shares associated with completed developments by getting the investor to help with initial equity and then obtaining planning permission. Once granted, you can raise the development finance for the build and pay back the equity.
- Consider Preferred Equity
Preferred Equity is a form of funding top-up which provides the necessary funds for a developer to buy and build a project with minimal cash input. Preferred Equity is often invested into a project in return for part ownership of the project. This could be shares in the company or a profit share with a priority return on the funds invested.
The source of capital can be from High Net Worth Individuals, Family Offices, Private Equity Institutions and, Crowdfunding platforms. Equity is paid for by a combination of interest, arrangement fees, exit fees and/or a profit share - typically 50% of profits. Similar to Joint Venture funding, they do take a larger portion of the profit through a high equity percentage demands, but they also do not require you to pay the money if it is lost in the deal. The main difference being that Joint Venture funding usually sits alongside you and gets paid at the same time you do. Preferred Equity is paid out before you get your own equity out of the deal and hence sits in a preferred position.
- Define your Capital Stack
The Capital Stack is the structure of total capital used to fund a property development or investment. Consisting of Common Equity, Preferred Equity, Mezzanine and Senior Debt finance, each level of the stack is associated with different risks and costs.
At the top of the capital stack is equity, the most expensive layer of finance and the most challenging type of finance to source and secure. Preferred and Common Equity give borrowers more access to equity capital without having to input all of their own cash into the investment.
Where you position yourself in the stack depends on the level of investment you find appealing, your personal financial circumstances and your appetite for risk. Determining the best capital stack for your project allows you to fine-tune your overall cost of capital, minimise your equity investment and maximise your returns.
If you require additional equity to start or scale your property development business, speak to our Funding Specialists today, who will be happy to discuss your best options.