Speaker 1: Paul, we’re going to go to you first. I’m looking to set up a venture with my wife of buying large properties and splitting them into two or three flats for resale. Perhaps three-story Georgian townhouses into three apartments. We’d appreciate some guidance on how to finance these deals and the necessary conversion work. Also, how should we structure it if this is a business? I know that’s music to your ears. You want to hear it’s a business.
Paul Mahoney: Yeah. It’s good they’ve described it in that way. So if I was answering all those questions in depth, we’re going to have to extend this show by about five hours. But to give a very brief … So three points they mentioned there. So if I were financing them, structure … What was the other one?
Speaker 1: How-
Paul Mahoney: The works involved.
Speaker 1: How to finance the works involved as well as the purchase.
Paul Mahoney: So there’s a number of different ways it can be financed. Generally what people do when they’re looking to buy a property to do works to it, to convert it, is either use development finance or short-term finance, being bridging. Now that would … That’s in a way determined by both price and experience. It seems that they’re just starting out in doing this as a business. So they’ll probably get the higher rates to start off with because they don’t have much experience. Development finance is usually for a period of 12 months plus, whereas bridging or short-term finance is usually for a period of less than 12 months. So that will be, I suppose, in a way determined by how long they expect these works to take. They obviously need, unless they do have experience in the works themselves or at least managing the works, they need to speak with someone who does have experience in that and get their advice on each and every project they’re considering, or each and every deal they’re thinking of doing, to give them a clear understanding of those things. And you always overestimate them and sort of don’t get caught up in your own hubris, I suppose. A lot of people become their own worst enemy by thinking they can do things a lot better than how it actually ends up.
Speaker 1: Well, I think it’s a clever person, isn’t it, that knows what their limitations are. And I think property development’s an ideal ground for that.
Speaker 1: But Paul, I wonder if you would just, for the benefit of our viewers not understanding perhaps some of the more technical terms you’re using, could you just briefly explain the difference between development finance and bridging finance?
Paul Mahoney: Yeah. So in short, development finance is, as it says on the tin, it’s for developments, but usually it’s for a period of 12 months plus. And usually it’s targeted at people that consider themselves developers, people with experience, I suppose.
Speaker 1: So a bit for the life of the development under construction.
Paul Mahoney: For the life of the development, ideally. A lot of developers, as I say, under-account for time and then need to use short-term finance to top themselves up. But ideally they would get it for the period for which they see the project progressing. And usually that would be a little bit cheaper than short-term finance. Short-term finance is the sort of realm that bridging finance fits into as well, and they’re pretty much both the same thing. But that is usually for a period of less than 12 months. Sometimes it will go for longer than that, but usually a maximum of 18 months. So for those types of-
Speaker 1: Why would you use bridging as opposed to development then?
Paul Mahoney: It’s usually easier to get. Usually experience isn’t considered as much, and that’s quite often because the rates are higher. So these lenders … Usually short-term finance lenders are willing to take a bit more risk than what development lenders in the true sense of the word are willing to take.
Speaker 1: So technically then you’d go in with bridging perhaps in theory and then replace it with development finance halfway through?
Paul Mahoney: Not usually, no. It’s quite often the other the way around, in that development finance is usually from the start. It probably can work both ways, but it’s more about what’s available to you given your profile, I suppose. But to give you a bit of an idea on rates, usually development finance is somewhere between 7% and 12% per annum, whereas bridging finance is quite often between 1% and 2% per month.
Speaker 1: Okay.
Speaker 1: Ouch, yes. Aisha, what do you say about it?
Aisha: I would say just be very cautious about which method of financing you choose and to make sure that it’s appropriate for the project. What you don’t want to have happen is to be on one finance path and to find out, for example if you’ve gone down the bridging route, the loan expires in 12 months, you have to pay it back but something’s gone wrong in your development and you need another six months. That’s a very, very uncomfortable position to be in.
Speaker 1: Presumably they’d be quite ruthless about the rates for extending.
Aisha: You don’t want to be on a loan that’s in default because typically what happens is it does ratchet up and it ratchets up quite a lot. So you need to be mindful about how long your project is going to take, give yourself a buffer, and get the right debt package in place with the right amount of time as well.
Speaker 1: Okay, John.
John: Where do we start? Goodness me. The first thing I would say, and Paul’s absolutely right here, don’t take too big a bite of the cherry. Start off with a small development, learn from that, get it done. Obviously development finance is the way to go. Make sure it’s rolled up, so you … In other words, the interest is rolled up to the end of the project. It’s very important that you’re not paying out every month. So roll the interest up to the end. Give yourself plenty of time. Give yourself two years, not a year and a half, to get it all paid back
Speaker 1: So in other words, to some extent-
John: And then a bit bullet payment. In other words, say it’s three flats, every time a flat is sold, you can arrange with the funder that they take 80% of every … 80% of the funds, or 90% or 100%. It depends of what the situation is.
Speaker 1: So the loan goes down to diminishing security, you’re fine.
Speaker 1: Would it be sensible in terms of building in time? Would you treat that in the same way that you’d perhaps build in a contingency of say 10% on your build cost? Would you take the same view over your finance?
John: Without question. I’d always add another six months on at least.
Speaker 1: Okay.
Speaker 1: All right.
Speaker 1: All right, thank you.