Development finance and profits

Question 1

What choice of interest rates are there?

Answer 1

• SONIA rate (Sterling Overnight Index Average)
• Bank of England base rate plus premium
• Rate at which developer can borrow the money

Question 2

Regarding finance, there are three elements that require finance where the developer needs to borrow money. What are these areas?

Answer 2

1. Site purchase (include purchaser’s costs) – compound interest (straight-line basis)
2. Total construction and associated costs – based on S-curve taking half the costs over the length of build programme.
3. Holding costs to cover voids until the disposal of the scheme (empty rates, service charges and interest charges – compound interest on straight-line basis.

Question 3

What spread of financing is assumed for the three areas that require financing

Answer 3

1. Site purchase – calculated on straight-line basis using compound interest over length of development period.
2. Total construction – ‘S’ curve calculation, assume total construction costs (including fees), the usual assumption is to halve the interest that would be borrowed for all of the construction period.
3. Holding costs – straight-line basis using compound interest. Costs from completion of construction until disposal.

Question 4

Why use an S-curve for total construction costs in cash flow model?

Answer 4

The weighting of the construction costs may be incurred irregularly within
a project and different property types may require a different pattern of delivery of
construction costs. Rather than being distributed equally over the development period,
generally the costs are quite small at the beginning of a construction project, relatively
accelerate in the middle and reduce towards the end of the construction period.

Question 5

What are the 2 main methods of development finance?

Answer 5

1. Debt finance – lending money from a bank or other funding institution
2. Equity finance – selling shares in company or joint venture partnership or own money used.

Question 6

What is Senior debt?

Answer 6

The first level of borrowing, which takes precedence over secondary/mezzanine funding.

Question 7

What is Mezzanine Funding?

Answer 7

Additional funding for the additional monies required over the normal LTV lending.

Question 8

What % profit is generally accepted?

Answer 8

15-20% profit on GDV
15-20% profit on construction cost
But it is dependent on risk

You can base profit on the return upon capital employed.

Question 9

Why do developers work on Profit on Cost?

Answer 9

• It shows true return on capital
• Balances risk and reward
• Fixed fees

Question 10

What is Overage?

Answer 10

• Arrangement made for sharing of any extra receipts received over and above the profits originally expected as agreed in a pre-agreed formula.
• Shared between vendor/landowner and developer in a pre-arranged apportionment.
• Also known as ‘claw-back’

Question 11

What is VAT?

Answer 11

Value Added Tax. It is payable on all professional fees.

Question 12

What is Profit Erosion?

Answer 12

Length of time it takes for the development profit to be eroded by holding charges following the completion of the scheme until the profit from the scheme has been completely drawn down, due to interest charges, and the scheme is loss making.