Understanding Bridging Finance for Property Development

While bridging finance was once a specialist product, it’s now being used more frequently across the UK. More and more property developers are starting to appreciate how they can utilise this short-term lending product to benefit their property transactions and businesses, be it for property development or property investment.  

The bridging market grew more than 8.5% in the first quarter of 2022 compared to 2021, with people using it for property investment.

But what is bridging finance for property development? In this blog we will cover the popular loan strategy, how it is used by property developers and investors and what to look out for when taking out a bridging loan.

• What is bridging finance?
• How does it work and who is it for?
• The benefits of bridging finance
• The drawbacks
• How do deposits and interest rates work for bridging finance?
• Crossing the bridge to property investment
• Example of Bridging finance being used in property development

What is bridging finance?

A bridging loan enables you to proceed with a property transaction while you:

• Free up money from other assets/investments.
• Build properties and sell them.
• Refurbish a property and then sell or raise long-term finance, for example, a buy - to -let mortgage.  

It enables a business to access a short-term cash injection, whilst a more sustainable plan is put in place or assets are liquidised.

They are generally used to support commercial and residential property transactions, auction purchases and renovation and development projects. There are two types of bridging loan:

• Closed bridge: The borrower has a set date when the loan will be repaid. For example, a person has already exchanged on a property and has a fixed completion date. The sale proceeds of that property will be used to repay the bridging loan.
• Open bridge: The borrower is required to have an exit plan to repay the loan, for example, once properties have been built and sold, but there is no definitive date at the outset. However, there will be a clear cut-off point when the loan is expected to be repaid.
  
  

How does it work and who is it for?

Bridging finance is a good option for landlords, property investors and developers who need to fund properties that cannot be funded through traditional commercial mortgages. 

Typically you can borrow between £50,000 and £10 million with a bridging loan depending on the value of the property or development project. 

Once your application has been approved by the lender, the property has been valued and any legal procedures are completed, then funds can be released. 

A lender would expect to see a clear exit strategy to repay the loan along with sufficient equity in the property/build to cover the loan, interest and fees.

The benefits of bridging finance

As with all types of finance, it is essential to understand the benefits and drawbacks to determine if it is right for you. Some of the benefits of bridging finance include:

• Flexibility: Bridging loans can provide you with a degree of flexibility when purchasing a property. This is because lenders generally offer terms of anything from a month up to 18 months. 
• Speed: You can get fast access to cash. Depending on the circumstances and the lender, a decision can be made within 24 hours of application and drawdown within 5 days. Although they generally take anything from 2 weeks to complete depending on complexity, this is still considerably quicker than long-term finance.
• Opportunity: Whilst conventional mortgages are generally only available for habitable property, bridging finance applies to land deals, refurbishment and construction projects. This enables the borrower to take advantage of projects that may have previously seemed impossible to fund.
  
  

The drawbacks for investors

Although bridging finance can be beneficial for borrowers, there are some drawbacks to keep in mind too. These include: 

Costs

There are fees to take into consideration including arrangement fees and exit fees As bridging loans are short-term, they tend to come with a higher interest rate which is usually calculated monthly as opposed to annually.

Risks

As a bridging loan will be secured against a property, this can become risky if the loan repayment is not met. It’s important to have a strong exit strategy and long-term repayment plan in place.

How do deposits and interest rates work for bridging finance?

The maximum loan, including any interest and fees, is typically 70% to 75% loan to value. However, there are some lenders, who depending on individual circumstances, will lend up to 100%.

Interest on term loans is expressed as an annual figure. With bridging loans, due to their short-term nature, interest is expressed as a monthly figure. 

The annual percentage rate (APR) is generally higher for bridging loans than other financial strategies. For example, if a bridging loan is advertised at an interest rate of 1.5% per month, it would lead to an APR of around 18%.  It is to be noted that 1.5% per month is at the higher end of the interest rates charged.

Bridging loans come with three main choices for interest repayment:

• Monthly: This is where you meet the monthly interest repayments from your own resources, and it is not added to the loan.
• Retained: Borrowing the interest upfront for an agreed time frame. When the loan is paid back, any remaining interest is paid back to you.
• Rolled up: Payments are added to the loan and repaid when the bridging loan is cleared.

All in all, bridging loans are useful and can offer a successful solution for property investors or developers, but they are sophisticated products and there is a myriad of lenders, it really is best to consult a professional broker who can guide you through the process of when and where to set one up to work to your best advantage.

Example Bridging Finance in Property Development

Consider a scenario where a property developer identifies a rundown property with the potential for renovation into high-value residential units. Unable to secure a traditional mortgage due to the property's condition, they opt for a bridging loan.

The Opportunity: With estimated acquisition and renovation costs totalling £500,000, the developer, let's call them 'Developer X,' seeks a bridging loan to bridge the financing gap.

The Solution: The developer secures a £400,000 bridging loan, covering acquisition and renovation expenses. They plan to refurbish the property and sell the units to repay the loan.

Execution: Quick access to funding enables the developer to acquire the property, complete renovations, and list units for sale.

Outcome: Successful sales generate profits exceeding the loan amount. They repay the loan, accruing interest and fees while enhancing their reputation in the property development sector.

Conclusion: This case study exemplifies how bridging finance empowers developers to seize opportunities, unlock property potential, and achieve profitable outcomes.