Want to Know Why We Use Other People’s Money For Our Developments?
- kelly40892
- Aug 26, 2022
- 2 min read
Updated: Sep 9, 2022
Well, it’s really simple. Here’s why!
If we only used our own funds, at some point we would run out of money or our growth would be adversely affected.
By using different types of funding to obtain the most competitive finance model, we have the freedom and ability to continue to grow without constraint.
In our experience, the question of using other people’s money is often based on a lack of in-depth knowledge around finance options and profit enhancing.
We have set out below examples of two of the most common funding models for developments and the finance costs associated with each.
Finance Model 1
The Senior Lender, or first charge lender, usually lends up to 80% of the total development costs. This is the cheapest and easiest to obtain pot of development finance. We would usually offer interest on this of around 6-7%, depending on the total value.
In addition, the senior lender will charge valuation and legal fees as well as additional fees upon entry into and exit from the loan – typically around 1% in and out.
The Mezzanine Lender, or second charge lender, will generally contribute a further 10-15% of the total development costs. The second charge lender has less security over their loan and is therefore requires a higher interest rate (up to 18%) to offset some of that risk. They too will charge legal fees as well as the same sort of entry and exit fees (1% for each).
The final 10% of the development cost will be funded by us as the developer. Just to give the investors a little comfort that we’ve also got some “skin in the game”, that we’re motivated and aren’t going to sail off into the sunset never to be seen again if things didn’t quite go to plan! (Just to be clear, we couldn’t do this anyway as we have to personally guarantee any investor loans against our own assets. So don’t worry too much!)
Here are two case studies based on a 12 month programme (figures for illustrative purposes only!).
Finance Model 1
Funds Required | £3,000,000 |
Senior/First Charge Lender Contribution | £2,400,000 |
7% Interest | £168,000 |
Arrangement/Exit Fees | £48,000 |
Mezzanine/Second Charge Lender Contribution | £300,000 |
18% Interest | £54,000 |
Arrangement/Exit Fees | £6,000 |
Our Contribution | £300,000 |
Finance Model 2
Funds Required | £3,000,000 |
Senior Finance Contribution | £2,400,000 |
7% Interest | £168,000 |
Arrangement/Exit Fees | £48,000 |
HNWI/SI Finance Contribution | £600,000 |
12% Interest | £72,000 |
Now, the total cost of debt (excluding legal and valuation fees) is £288,000 which provides a blended rate of 9.6% p.a.
Institutional enders will deduct their arrangement fee and interest from the gross advance, whereas a private lender does not.
Based on this example, we would receive finance of £2,808,000 meaning that wet have to put in £192,000 as our “skin in the game” (not forgetting about those personal guarantees of the senior loan).
By funding the project in this way, we can reduce the cost of our finance and increase our available funding. The investor still receives an excellent return on their money by leveraging their skills, experience and balance sheet.
We’ve said it before and we’ll say it again, you don’t get those kinds of returns if your money is sitting in the bank!
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