When looking at property development opportunities the vast majority of people will need to take on a certain element of borrowings. The idea is to buy the property as cheaply as possible, use borrowings to fund refurbishment and sell on for as large a profit as possible. In theory this is all very straightforward, but one issue which many people fail to understand is the level of borrowings required.
Give yourself headroom
Let’s say you acquire a property for £100,000 and then look to arrange borrowings of £50,000 to renovate the property. How firm is this £50,000 budget? Are you working on a very tight schedule using cheap materials?
One issue which needs to be fully understood when looking to develop property is the fact that any delay in completion cost money. It is lost money in rental income/sales proceeds and additional finance charges which can very quickly start to bite into your financial projections. Therefore, when looking to arrange borrowings to complete a redevelopment/renovation you should give yourself some financial headroom. However, surely this would increase your interest charges?
The vast majority of companies who specialise in redevelopment finance will offer you stage payments. This means that rather than passing on all of the borrowings in one go they would release previously agreed amounts once certain targets have been hit. This incentivises the investor/developer to keep up with the schedule, this ensures the bank is not overextending itself but most importantly, you’ll only pay interest charges on payments received. So, if for example you estimated a £50,000 budget for redevelopment of your property then it may make sense to have in place a £60,000 borrowing facility.
If you do require additional funding over and above the initial £50,000 budget forecast then you can draw down the additional £10,000 as and when required. You will only pay interest from the day you draw down the additional funds and if you stick by you budget then you won’t require the additional funding. There is no point arranging a £100,000 borrowing facility if you are unlikely to use more than £50,000 so you need to be sensible because ultimately an excessive borrowing application would be rejected.
Applying for additional funding
If you present your project to the bank and they agree with your budget and arrange a £50,000 borrowing facility, what happens if you require more funding? If you decide not to give yourself headroom on your initial borrowings then you will need to go “cap in hand” to the bank or another financial institution. There’s a good chance that you may experience difficulties trying to arrange additional finance after the event and even in the best case scenario you may be forced to pay a higher interest rate compared to the original funding.
It is far better to give yourself that bit of headroom and additional funding, which may or may not be used, than to be forced to make an additional application for further borrowings. Financial institutions are unlikely to look favourably on so-called distressed borrowers!