Property developments are financed by a developer borrowing money to fund the purchase of land and the construction of buildings. Development finance requires a number of contractual considerations and instructing a development finance solicitor is essential to ensure you get the right finance for your development.
Here we'll be covering:
- How does development finance work?
- When might finance be necessary for a development project?
- What are the types of property development finance available?
- What are step-in rights?
- How is the borrowing secured?
- What is a debenture?
- What contractual rights does a lender have?
- What is Practical Completion?
- What is the effect of Practical Completion?
How does development finance work?
A development finance transaction works by a developer borrowing money from a lender (or lenders) to finance the acquisition of land and the subsequent property development. After the building is completed, the property will be sold or used as an income source for investment purposes.
The money borrowed is secured over the property and the rights of the developer.
When might finance be necessary for a development project?
Large projects will require ground-up development finance that covers all costs involved with the purchase and construction. Finance will be taken over many months or years, in intervals, up until the completion of the project. The property development finance will likely be 70-80% of the building cost. The balance of the cost will normally be met through subordinated loans and or equity.
What are the types of property development finance available?
Development finance loans may be bilateral (a single lender) or syndicated (several lenders), although syndicated loans are more common.
Typically the borrower is a special purchase vehicle (SPV) and the loans will be secured over specific assets or revenues of the SPV. The finance documents may allow a lender to step-in to manage the affairs of the borrower.
What are step-in rights?
Step-in rights are contractual clauses that allow one party to take the place of another. In property developments, step-in rights allow a lender to step into the shoes of an insolvent developer to ensure the completion of a project.
Step-in rights can give the lender the benefit of the developer’s rights as employer of a building contractor or a professional consultant. A developer may also have step-in rights to take over the benefit of the rights of its subcontractors.
Typically step-in rights will require one party to serve notice to another of its intention to exercise its step-in rights.
How is the borrowing secured?
A development finance transaction will typically include more comprehensive security than in real estate investment finance. This is because the value of the undeveloped land is likely to be less than the cost of funding the development.
The security will typically include:
- a debenture (including mortgages, fixed and floating charges)
- contractual rights
- a charge over bank deposits
- intellectual property
- insurance policies
- plant and machinery
- collateral warranties
What is a debenture?
A debenture is a document securing corporate indebtedness through fixed and floating charges.
Fixed charges give a lender security over specific assets of a company which are not disposed of in the course of business. In a development finance transaction this will include the land acquired.
A floating charge is security over the remaining, but unspecified, assets of the company.
What contractual rights does a lender have?
A lender will expect to take security over the key development documents. The key development documents include:
- the building contract
- the development agreement
- collateral warranties
- acquisition agreement for the land
- operating agreement
- bonds, guarantees or letters of intent
- professional appointments
A lender will want to be able to assign the rights under the contract to itself in the event that the borrower is unable to complete the development.
What is Practical Completion?
Practical completion confirms the completion of construction works on a project. It represents the end of major works, although minor improvements on site may still occur.
The Joint Contracts Tribunal (JCT) suite of contracts defines ‘practical completion’ as:
‘Practical Completion takes place when the Project is complete for all practical purposes and approvals obtained and, in particular:
- the relevant Statutory Requirements have been complied with and any necessary consents and approvals obtained;
- neither the existence nor the execution of any minor outstanding works would affect its use;
- any stipulations identified by the [employer’s] requirements as being essential for Practical Completion to take place have been satisfied; and
- the health and safety file and all ‘as built’ information and operating and maintenance information required by this Contract to be delivered at Practical Completion has been so delivered to the Employer.’
What is the effect of Practical Completion?
Practical completion has a number of implications. Practical completion ends any rights to liquidated damages for a delay to the works and typically entitles the contractor to a percentage of the retention monies (usually 50%).
Practical completion also marks the beginning of the defects liability period and will trigger the final account process in JCT contracts.
Disputes as to whether practical completion has been achieved are common and it is important that you check that the building contract is clear on when practical completion occurred or is deemed to have occurred.