What is construction finance?

Long payment terms and late payments are some of the biggest problems facing construction firms. Construction finance is designed to ease these cash flow problems by advancing cash against uncertified applications for payment, staged invoices, or sales invoices.

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What is construction finance?

The construction industry is wrought with complexity. When financing a construction project, to ensure it runs as smoothly as possible, you will need a source of finance that can handle contractor delays, price increases, and unexpected expenses.

Construction finance provides the capital to fund new projects in the construction sector, mostly, but not always, used by construction companies to plug the gap between work done and receiving payment for said work. This type of funding is mainly used to pay subcontractors, purchase materials, and effectively manage working capital in projects where cash flow is difficult to predict.

There are several different forms of construction finance, from secured and unsecured business loans to equipment leasing. It is particularly important for small construction businesses registered in England and Wales; however, terms and conditions will apply.

How to fund a first-time construction project?

Let’s say you have completed or partially completed a new construction project and are awaiting payment. Once you have sent out an invoice, whether it is an uncertified application for payment, a staged invoice, or a sales invoice, a construction finance lender can assess your application. 

If the lender is happy with your documentation, they will issue a prepayment within 24 hours — a process that can now be done fully online. The amount available as a prepayment will depend on your credit rating and the value of outstanding billing, but it can be up to 70% of the total value of your payment application. A finance facility connected to a specific invoice will usually be less than if the application is against your entire sales ledger. This process is similar to invoice finance.

It’s worth noting that

  • You can use the cash for any business purpose 

  • If you apply for a new source of short-term funding against new bills, an additional cash advance will be provided

  • If your construction contract is complex, i.e it contains contractual debts, retentions, extended payment terms, or project-based transactions it is still possible to secure funding

How to get a construction loan as a first-time developer?

The decision for a lender to issue a building loan comes down to the level of estimated risk. A first-time developer poses a high level of risk, and often lending underwriters will be cautious when they receive an application for building funds from a first-time developer. However, it’s not all doom and gloom for inexperienced developers looking for capital.

First, as a business owner, you will already have a skill set that makes it easy to analyse and plan costs — this will go a long way to convince a lender that you understand the full costs of your development and have the competence to manage cash flow throughout the project. 

This lack of understanding is why most first-time developers fail to get finance. Nevertheless, if the loan application is packaged correctly by an expert who understands the construction finance lending market, for example, via a lending platform, the chance of securing a loan for building work can be enhanced significantly.

The reason for this is construction finance is different to a regular loan application, but is more like a comprehensive business plan with project timelines such as:

  • The acquisition of land/buildings

  • The cost of building, insurance, marketing, professional fees, and architects

  • Any potential legal issues and how they might be resolved

  • Exit plan (sale or lease of the development), incl. how the loan will be repaid

How to negotiate your first development construction loan

When applying for a loan for a new UK construction project, there are three areas where you may have room to negotiate the terms of your loans: interest rate staged drawdown, and the length of the facility. Given that many building companies will be tied up in lengthy projects that require finance for staged payments, for example, a concrete firm laying poured concrete in an apartment.

Interest rate

The interest rate you secure with a lender will greatly impact the overall profitability of your development project. With a comprehensive business plan that conscientiously demonstrates your ability to deliver on previous projects and a meticulous understanding of the minutiae of the construction costs and timelines, you can secure a low-interest rate. In addition, you can ask for the interest to be “rolled up” so it only becomes payable upon completion of the loan term or settlement, whichever comes first.

Staged drawdown

This type of lending for construction allows you to take money from your facility when you need it. Hence, you won’t have to pay any interest on the balance.

Length of facility

It’s almost guaranteed that there will be project overruns, even if the most experienced team is working on a project with tight scheduling. By extending the time you have to pay back your facility, you will have more flexibility to repay the loan without paying interest penalties for early settlements.

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