There’s a wealth of information out there about how to find investor finance for your property developments but there’s borderline nothing about actually providing developer finance.
How do you find developers to work with? How much should you loan them? How risky is it? What due diligence do you need to do? What paperwork should be in place? How much interest should you be charging?
Many questions, few answers currently available and way too much content out there posted by developers themselves and not actual investors.
I want to change that so I’m sharing my process in the hope it will benefit anyone considering providing developer finance.
NB: at the time of writing this post I have £152,000 loaned out between three developers and have been providing development finance for a little over three years.
How To Find Developers
You’ve got multiple outlets and (shockingly) there are plenty of people looking to get their hands on your money.
- Property forums aren’t a bad place to start looking. Property Tribes and The Property Hub are two I read and developers are lurking and posting on both.
- Podcasts are another sure fire hit for finding potential investments. The majority of podcast owners are actively seeking investment themselves and if they’re not their guests certainly are. Tej Talks, J2Hub and Inside Property are a decent starting point although many more are out there (I don’t worth with any of these guys direct but have found developers via their podcasts).
- Social media is another home run for finding developers and pretty much all are
boastingposting on Instagram and Facebook about their latest deals. Word of warning here… no one ever posts anything bad on social platforms so just remember that before getting too sucked in by lots of pretty pictures. - Conferences are not somewhere I’ve found developers, we are in the middle of a pandemic and all, but they’re there and actively looking to connect with money.
How Risky Is Providing Development Loans?
How anyone quantifies risk is subjective but for me loaning money for property development sits somewhere between index or managed fund investments and the hyper volatility of Bitcoin.
What does that really mean?
It means that there is likely a level of risk involved beyond that of just the risk of the stock market rising or falling however this risk can be mitigated by picking the right candidates and doing your due diligence.
For some context… property development loans make up just under 10% of my overall investment portfolio at this moment in time and because of that I don’t consider these loans as particularly risky.
Your two core risks are:
- The actual person you are investing in – they need to know their market and know their figures because to get your money back to you plus interest is going to mean hitting at least their minimum final valuation.
- The property market – usually these types of investments are done over a period of up to 12 months. If the market crashes in that time your developer is going to struggle to get your money back out plus interest regardless of how smoothly the project has gone.
How Much Should You Loan Out?
I can’t tell you the answer to this question other than to say that you should only loan an amount you are comfortable with loaning (like duh obviously).
Portfolio diversity is your number one defence against any one specific market or investment turning against you.
The more you split your money the less each individual investment matters to your overall returns.
Personally I don’t think I’d want more than 20% of my overall capital invested into these types of loans unless I had a very strong reason to do otherwise. Property is a big enough part of my portfolio as it is.
Note: there’s nothing wrong with starting small with a developer (£10,000-£20,000) and building a relationship over time where eventually you’re willing to loan much more.
It’s also worth noting that I only loan the property purchase price. I like the developer to be paying for the refurb so they have some skin in the game. It also prevents them coming back asking for more money when they’ve underestimated their refurb costs.
What Due Diligence Do You Need To Do?
Due diligence… snooze-fest right?
Well it might be boring but it’s your number one line of defence against making a bad investment.
You wouldn’t buy shares in a company you knew nothing about so similarly you shouldn’t be loaning money to anyone you haven’t researched thoroughly.
I consider the following the absolute minimum number of checks you should run on any potential candidate…
Social Checkups – go through all their social media posts from the last couple of years. Read the comments for any sign that things might not quite be hunky dory. Try to do this for personal as well as business accounts if separate.
Investor References – ask for references from investors who have loaned to this developer in the past. I prefer to get their details and then politely approach asking for an honest review of the developer in question. Direct contact allows for more transparency. It’s much easier to criticise someone if they aren’t seeing what you’ve written or hearing what you’ve said.
Proof Of Ownership – get the developer to tell you about what projects they’re currently working on and then when you’re doing your due diligence ask to see proof of ownership for these properties. It should be easy for them to provide a copy of the Land Registry Title Deed for any property they own.
Companies House Search – regardless of how your developer is buying, personal name or limited company, search their details on the Companies House Register. You can then credit check any company they are or have been associated with in the past to look for creditworthiness and any financial issues (specifically CCJ’s).
Credit & CCJ Check – you should be running a credit and CCJ check on the developer as well as anyone associated to their limited company (this information is easily obtained when you search companies house). I use TrustOnline to check CCJ’s and Experian to credit check limited companies – both have a small charge. You can’t actually credit check an individual, to my knowledge, but the CCJ check should be good enough to show any issues.
Solicitor Check – get the name, address and phone number of the developers solicitors. Check them out online and pop them a quick message to make sure they are actually engaged by said developer. Never send money directly to the developer. Deals will always be done through their nominated solicitors.
The above sounds like a lot more work than it actually is… we’re talking about an hour or two of your time, which if you can’t afford to spend protecting your investment, you shouldn’t be investing in the first place.
What Paperwork Should Be In Place?
I’m not a legal expert so there might well be other, or even better ways, to document this type of deal but to date I have always had the terms of the loan agreement written into a CH1 form (HM Land Registry Legal Charge of a registered estate).
This form gives the lender first charge over the property should the developer default for any reason. It basically puts you in the same legal position as a bank when they give out a mortgage.
NB: please seek independent legal advice on any form or contract you sign when providing developer finance and make sure you fully understand what is expected of each party and what the process will be to reclaim the property should the deal go sour.
Personally I like to have certain terms written into this agreement upon which the developer must comply. These include:
- Stated loan amount
- Amount of repayment plus interest due.
- Date of repayment deadline (my preference is usually 12 months)
- Penalty for late repayment (4% above base rate)
- Responsibility for the borrower to insure the property
- Undertaking for the borrower to only carry out work to the property which will increase it’s value.
- Significant demolition must be pre approved by the lender before work commences.
- Fully entry to inspect while the charge is outstanding.
The CH1 form is the only piece of paperwork I use to secure my property development loans. I am unwilling to loan without this charge in place however may consider it if a personal guarantee was offered depending on the developers circumstances (ask your solicitor about personal guarantees – it’s not just a word of mouth thing).
How Much Interest Should You Charge?
Many property developers have a fancy pdf which documents how, depending on the length of time you loan them money, you can get between 6-8% back when the deal is complete.
Personally I won’t loan developers funds on anything less than a 10% interest rate.
The reason for this is simple. I believe than in an index or managed fund I can return in the region of 6-8% and I rate this type of investment as more risky. Therefore a higher ROI is required.
You NEED to remember that developers need your money.
Social media allows developers to build hype around their brands and to paint themselves as property gurus. Many even brag about how many investors they have or how much capital they have raised in order to build fomo (fear of missing out) amongst their audience.
It’s easy to get sucked into this and forget that this type of investment comes with a reasonable level of risk, more so than many standard options, and forget that you should be well remunerated for taking that risk.
On top of this you need to decide if you’re willing to apply your interest rate as a set fee, regardless of when the deal completes, or if you’re willing to do it on a pro-rata month by month basis.
The former is much better for the investor as if the deal completes early then your rate has the potential to be higher than 10% – always push for this – I have done both.
Remember: you have the power because you have the money in this situation. Without investor funds many developers simply can’t do deals. Don’t be afraid to walk away from a developer if they won’t meet your demands.
It’s also worth nothing that the agreement you are entering into is a partnership of sorts and apply leeway as you see fit, remain human, you’re not a loan shark and ideally you’re looking to build a long term relationship with trusted developers.
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