In its most basic form term lending is a monetary loan that is repaid in regular payments over a set period of time. Traditionally this agreement would be between one year and 10 years in duration but is often extended in certain circumstances. As well as capital repayments there would be additional interest payments which can be fixed or floating. Used correctly, short and long-term loans can create significant uplift in the value of a property development.
Sometimes referred to as “bridging loans” or “refurbishment loans” these types of short-term lending are extremely useful in the early stages of a property development. If a developer has land/existing premises which they would like to develop/redevelop they can borrow money on a short-term basis to cover the development costs. Some companies will lend up to 100% of the redevelopment costs but this will vary from project to project.
For example a property worth £50,000 may require a further £50,000 in development costs before it is ready to be marketed. The property investor would take out a short-term £50,000 loan and use this to upgrade the property. The idea behind the short term loan is that once the property has been redeveloped it would see an increase in value to, for example, £150,000. This is where long-term lending comes in because using the uplifted value of the property a loan of for example £100,000 could be secured with £50,000 going to pay off short-term loan plus additional interest. This would leave a surplus of circa £50,000 and a paid up equity interest in the property (this equity interest would increase as the loan was paid off).
There are many uses of long-term lending in the property development market. One of which we have highlighted above, using development capital to uplift the value of a property and then long-term lending to redeem the short term debt, raise surplus capital while creating an immediate equity stake in the property.
Long-term lending is also very useful in the acquisition of fully developed property assets which can be rented out to 3rd parties on a long term lease. The idea being that the rental income less running costs will more than cover repayment instalments on the long-term debt. At the end of the term loan the investor would be left with a 100% equity stake in the property and no debt. In theory property finance companies would go as high as an 80% loan to value figure although this would depend upon individual circumstances.
The risks, benefits and security needed for different terms of lending
One of the best ways to utilise short-term and long-term lending is to use fully paid-up equity in existing assets as security. This allows property investors to fully utilise their assets to raise additional capital without actually selling any assets. Where there are no existing assets to use as security, aside from the asset which requires funding, the loan to value may be reduced requiring a greater initial deposit. Individual lending terms will vary from project to project but it is vital that you fully utilise all existing assets and cash deposits in the most efficient manner.
There are obvious risks such as increased redevelopment costs and slippage in the development timetable which extend the period from which the asset will be income producing. As the assets may be used as security (or other assets) cash flow problems and an inability to cover ongoing financial liabilities could see the lender taking control of these assets. They would then likely be sold as quickly as possible, probably below market value, with the property investor then liable to any additional shortfall. Those who look to acquire properties to redevelop and “flip” very quickly may also fall into financial difficulties if the market turns and the property falls in value or they simply fail to sell the asset.
Whether an investor goes for short-term or long-term lending they will need to put forward some kind of security against the loan and fund part of the costs themselves. Used correctly short-term funding can significantly uplift the value of a property asset. Long-term lending can then be used to release this uplift in the shape of surplus capital. This would extend the loan period with a more manageable repayment program thereby improving cash flow.