Property development is a complex venture where success hinges on careful planning, especially when it comes to repaying development finance.
An exit strategy is not only about maximising profits; it’s primarily about ensuring you can repay your development loan on time (or at least that’s what the lender is interested in).
This article explores various exit strategies available to property developers, helping you make informed choices to meet your financial obligations.
How confident are you in your current exit strategy? Let’s explore your options to ensure you’re well-equipped to meet your financial commitments and potentially maximise your profits.
Understanding Exit Strategies in Property Development
An exit strategy is your plan for concluding a property development project, with the primary aim of repaying your development finance.
It’s not just about the end of the project; astute developers consider their exit strategy from the very beginning, often before even securing the loan.
Exit planning is closely tied to your loan terms and overall project goals.
Early planning can significantly influence your project’s direction and ultimate success. For example, a developer with a 12-month loan might plan for a quick sale upon completion, while one with an 18-month term might consider a phased exit strategy.
Why Lenders Prioritise Exit Plans
For property development lenders, the exit plan is arguably the most critical aspect of any loan application. Here’s why:
Loan Repayment Assurance
Fundamentally, lenders are in the business of providing capital and receiving it back with interest. A robust exit strategy provides lenders with confidence that the developer has a clear, viable plan to repay the loan. This assurance is vital, as development finance involves substantial sums and relatively short terms.
Risk Mitigation
Property development inherently carries risks, from construction delays to market fluctuations. A well-thought-out exit strategy demonstrates that the developer has considered various scenarios and has contingencies in place. This risk awareness and planning significantly reduce the lender’s exposure.
Market Alignment
A strong exit plan shows the lender that the developer understands the current market conditions and has tailored their strategy accordingly. Whether it’s a quick sale in a booming market or a phased approach in a more challenging environment, alignment with market realities is needed for successful loan repayment.
Project Viability Assessment
The exit strategy often serves as a litmus test for the overall viability of the project. If a developer struggles to articulate a clear exit plan, it may indicate issues with the project’s conception or the developer’s understanding of the market.
Liquidity Management
Lenders need to manage their own liquidity and cash flow. Knowing when and how loans will be repaid allows them to plan their own financial strategies more effectively. A clear exit plan helps lenders forecast their cash flows with greater accuracy.
Regulatory Compliance
Many lenders are subject to regulatory requirements regarding their loan books. A solid exit strategy helps ensure that loans are likely to be repaid within the agreed terms, helping lenders maintain compliance with regulatory standards.
Experience Indicator
A well-written exit strategy often indicates a developer’s experience and professionalism. Lenders tend to have more confidence in developers who can demonstrate a track record of successful exits from previous projects.
Flexibility and Adaptability
While lenders appreciate a clear exit plan, they also value flexibility. A good exit strategy should have built-in alternatives or contingencies, showing the lender that the developer can adapt to changing circumstances while still prioritising loan repayment.
Lenders may additionally request detailed cash flow projections, market analysis, and even pre-sale or pre-let agreements as part of assessing the exit strategy.
They might also consider the developer’s track record with previous exits and their relationships with estate agents or commercial property agents who will be involved in executing the exit plan.
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Common Exit Strategies for Property Developers
Sell Upon Completion
Selling your entire development after completion is a straightforward strategy that can ensure quick loan repayment. This approach works well in a strong market where demand for new properties is high.
Benefits include a clean break from the project, timely loan repayment, and potentially significant profits if the market has moved in your favour during the development period. However, risks include market downturns during construction and the possibility of slow sales if the market cools, which could jeopardise timely loan repayment.
Sell Off-Plan
Selling properties before or during construction can provide early cash flow, potentially allowing for partial loan repayments during the development phase. This strategy can be particularly effective in hot markets where buyers are keen to secure properties early.
Off-plan sales can help finance the construction process and reduce the overall loan burden.
However, it’s not without risks. If property values decline during construction, you might face buyers attempting to renegotiate or back out, potentially affecting your ability to meet loan repayments.
In major UK cities, off-plan sales have been a significant part of the new-build market, providing developers with early funds to service their loans.
Refinance and Hold
For developers with a long-term vision and the ability to secure favourable refinancing terms, this strategy can help repay the development loan while creating a steady income stream.
This strategy involves refinancing your development loan into a longer-term mortgage upon completion.
It can be particularly effective if you’ve developed in an area with strong rental demand and growth prospects, allowing you to repay your original loan and potentially benefit from ongoing rental income and capital appreciation.
Let’s look at a simplified example. Suppose you develop a block of 10 apartments with a £2 million development loan. Upon completion, they’re valued at £2.5 million. You could refinance at 75% LTV, releasing £1.875 million to repay most of your development loan, while rental income covers the new mortgage and provides additional cash flow.
It would also be possible to sell 5 of these units and keep 5, balancing the need for capital now and building profit for the future.
For commercial properties, it’s quite common to utilise development finance for the land and build phase, then obtain a commercial mortgage as a means of repayment. You would need an Owner-Occupier Commercial Mortgage if you intend to run your business there, or a commercial investment mortgage if you are letting the building out.
Phased Exit
A phased exit involves selling your development in stages.
This strategy can help manage cash flow, adapt to market conditions, and ensure steady loan repayments throughout the project lifecycle.
Phased exits work well for larger developments or those with a mix of property types. They allow you to begin repaying your loan with the proceeds from early phases while potentially benefiting from value increases in later phases.
Consider the example of a mixed-use development in Bristol. The developer released residential units in phases, using the proceeds from each phase to repay portions of their development loan. Meanwhile, they held onto the commercial units until appropriate tenants were secured, maximising the overall value of the development while meeting their loan obligations.
Adapting Exit Strategies to Market Changes
Flexibility is key in property development.
Market conditions can change rapidly, and successful developers are those who can adapt their strategies accordingly while still ensuring they can meet their loan obligations.
Continuously monitor market conditions, including factors like interest rates, employment levels, and local development plans. Have contingency plans in place for different scenarios that could affect your ability to repay your loan.
Consider the experience of a developer in Manchester who originally planned to sell apartments upon completion to repay their loan. When the market softened, they adjusted to a partial hold strategy, selling some units to make partial loan repayments and refinancing the rest on a buy-to-let basis.
This allowed them to meet their financial obligations while waiting for the sales market to improve.
Refinancing the whole deal
In a situation where you can’t sell the units within the agreed time-frame you may need to consider refinancing the site with a new lender.
This would involve development exit finance.
If the existing lender refuses to provide a term extension, your only option may be to refinance.
Development exit finance is a specialised lending solution for property developers in the latter stages of their projects.
It’s a short-term funding option that replaces your existing development loan, often with more favourable terms and greater flexibility.
This type of finance is designed to provide developers with the breathing room they need to complete their projects without the pressure of looming deadlines from their original lenders.
It can be particularly useful when unexpected delays or market conditions have affected the original project timeline.
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Remember, every project is unique, and what works for one may not work for another. Regularly review and update your exit strategies, always keeping your loan repayment schedule in focus. Seek professional advice when needed, and stay informed about market trends.
Need some help?
If you need a bridging loan or development finance then a specialist broker is a good place to start. You will get expert help and advice along with a wide range of lenders to choose from.
To get matched with a specialist broker, please call us on 0330 030 5050.
