How to Finance Property Development
Find out how to finance property development, whether you’re a landlord, a business acquiring your first premises or a property developer.
It’s not uncommon for the team at NerdWallet to be asked the question: ‘can I buy a house with a business loan?’. In this article, we’ll answer this question, as well as explaining the possible methods to finance property development.
There are many ways to finance property development - the most common forms of finance available are commercial mortgages, buy-to-let mortgages and bridging loans.
A large number of professionals in the property sector use business loans to finance property development, including investors, developers and landlords.
Here, we explain the options for funding property for investment purposes.
Raising money for property development
For anyone new to property finance, our clear guide on how to raise finance to fund a property purchase will help you to make an informed decision on what type of finance suits your financial position, as well as what is suitable for the type of property you wish to purchase.
There are potentially great financial opportunities involved in property development, alongside equal risks.
A clear risk is raising property development funding which you will be unable to afford in the long-term, any missed repayments will damage your credit rating, or create the possibility of getting into debt.
Another major risk of property development is that your property will depreciate in value. This is an inherent risk when investing in the property market, meaning you are at the mercy of the markets and the sentiment that shapes it daily.
However, what is in your control is the type of finance you apply for.
To help you make the right choice, we’ve set out the major differences between the various funding options available.
As the name suggests, commercial mortgages are used to fund the purchase of property that is not your personal home.
A commercial mortgage could equally be used to fund the opening of a new high street shop, to acquire the rights to warehouse space for a new or expanding business, or for a business wanting to own their office space.
This is perhaps the most common use of a commercial mortgage as it allows business owners, particularly small business owners, to own their office space - providing a permanent base for operations which creates stability and a strong base for growth.
It is usually easier for an established business to secure a commercial mortgage, but it’s certainly possible for small businesses too.
A commercial mortgage is, in most regards, extremely similar to a traditional mortgage and works in much the same way. The great benefit of a commercial mortgage is the potential to spread repayments over a long period of time.
To land a commercial mortgage, businesses will need an exceptional credit history and track record, but that should not dissuade ambitious businesses from applying for one.
Buy-to-let mortgages are usually acquired by anyone wishing to buy a property as an investment, by renting it out. They cannot be used by those wishing to live at the same property as a live-in landlord.
A key benefit of buy-to-let mortgages for landlords is that they often have favourable rates compared to other types of business finance.
A buy-to-let mortgage is a form of secured lending, for landlords who wish to buy a property to rent it out to tenants which ultimately generates the income for the landlord.
When deciding whether a buy-to-let mortgage is right for you, it’s worth noting that they usually need a much higher minimum deposit than a residential mortgage. Not only that, but buy-to-let mortgages typically have higher interest rates.
This can cause greater financial strain to those without the resources to cover associated inflating costs.
Bridging loans are a popular form of finance for property developers.
If a property developer wishes to act fast and buy a property before funds have been released from other property being sold, a bridging loan can be used to complete the purchase.
Or, as stated earlier, a bridging loan can be taken out by a property developer who is looking to do more extensive work on their existing property or has plans to build a property from the ground up.
The type of finance best suited to a property developer depends upon the scale of the development they are looking to build. The extent of the building work necessary in a development has a major impact on whether a bridging loan or buy to let is right for you.
This is because extensive property developments often require additional funding.
Developers should typically consider a bridging loan when their development is classed as heavy refurbishment or a ground-up development.
- Heavy refurbishment - includes changes a property’s aesthetics, including moving or knocking down internal walls, replumbing and rewiring
- Ground-up development - involves the construction of a new development from a previously unused piece of land
Bridging loans therefore may be most appropriate for landlords and private individuals looking to redevelop a property to improve its potential sale value. They are also suited to property developers constructing new properties on a grand scale, such as a new block of flats, an office building or a shopping centre.
Bridging loans have a shorter duration than other types of loans. They are intended to be the financial ‘bridge’ between other types longer term financial options, and must be repaid in the term agreed. If your project does not go to plan your bridging loan will become an expensive form of borrowing. Make sure you are clear on these before you consider one.
Is it best to buy your property as a private individual or through your limited company?
What are the advantages and disadvantages of buying property via a limited company or as a personal purchase?
Changes to government legislation in 2015 and 2018 mean that landlords could benefit by purchasing property as a limited company.
These changes included the lowering of mortgage interest rates for limited companies.
This means that, for some landlords, their mortgage costs can be lowered over time, should they secure their mortgage as a limited company.
Whether you should buy property as a private individual or through a limited company depends on how many properties you wish to buy and how you plan to use them.
Advantages of buying property as a limited company
- You will be charged corporation tax rather than income tax. Corporation tax is often significantly lower than income tax for the same material earnings
- Dividends from your property can be invested in future purchases
Disadvantages of buying property as a limited company
- It can be challenging to find a buy-to-let lender who is willing to lend to a limited company
- Often, lenders require a form of guarantee from the company’s directors
- In the case of a default, the director of the company will then be liable to repay the loan
- Limited companies may face higher interest rates and lower loan-to-value ratios
- There are less buy-to-let loan products for limited companies as compared to private individuals, meaning fewer competitively priced loans are available
Compare property development funding products
NerdWallet compares a range of property finance products in our loan comparison tables.
By comparing various property development funding products, you can make an informed choice on which will give you the longest time period to pay back your loan at the most manageable interest rate, should you go ahead with a property development project.
Peter reports on a number of areas in the personal finance sector, with a particular interest in supporting businesses and individuals in the UK services industry. Read more