Build to rent funding and forward funding

Build to rent funding is the money used to buy land and build homes that will be kept and let rather than sold. It can come from development loans, equity from the developer or partners, or an investor that agrees to fund or buy the scheme. Most larger schemes combine more than one source, structured around the build programme.

Because the homes are not sold, the developer cannot repay a development loan from sales as on a build-to-sell scheme. The funding plan therefore depends on a refinance onto a long-term loan once the homes are let, a sale of the whole scheme to an investor, or an investor funding the build from the start.

Under forward funding, an investor agrees to buy a scheme before it is built and pays for the construction in stages as the work progresses. The developer builds the scheme and usually receives a profit on completion, while the investor owns the land and the finished homes. Forward funding is widely used by institutional investors entering build to rent.

The investor carries less construction risk than it might appear, because the developer is usually bound by a development agreement with a fixed price, a programme and quality standards. The investor's monitoring surveyor checks each stage before money is released, much as a development lender would.

For the developer, forward funding removes the need for a large development loan and secures the exit before work starts, though it usually gives up some of the profit in return for that certainty.

A forward commitment is an investor's agreement to buy a completed scheme at an agreed price once built, without funding the construction. The developer funds the build with a development loan and equity, and the commitment gives the lender comfort that the loan can be repaid on completion. It carries more risk and reward for the developer.

Lenders look closely at the terms of the commitment, the investor's financial strength and any conditions that must be met before the purchase completes, such as practical completion by a set date or reaching a level of lettings.

Where there is no forward funding, build to rent schemes are usually financed with development loans sized against total cost and the expected value once let. Interest is normally rolled up during the build, and the loan is repaid by refinancing onto an investment loan when the homes are let, or by selling the scheme to an investor.

Lenders allow for the lease-up period, when homes are being let for the first time and income is building, either by giving a longer loan term or by expecting a short-term bridge before the long-term refinance. How investors measure the income and value of a let scheme is covered on the build to rent investment and yields page.

Funders review planning permission, including any affordable housing obligations and conditions on how the homes can be let, along with the developer's track record, the contractor, the build contract, the cost plan and the programme. They also look at the local rental market, the proposed rents and the operator who will manage the homes once complete.

Many schemes set aside some homes as affordable private rent under planning agreements, which affects income and value. Building safety requirements for taller blocks, energy performance standards and the design of shared amenities are also part of the review, because they affect operating costs and the long-term value of the scheme.

Forward funding for build to rent usually comes from institutional investors such as pension funds, insurers and specialist residential funds that want long-term rental income. They often prefer to fund schemes from the start so that the design, specification and amenities match their requirements, rather than buying completed schemes built to someone else's plan.

Some investors work repeatedly with the same developers, which can speed up later deals. Others run competitive processes, inviting several developers to propose schemes on sites the investor already controls.

Build to rent funding costs include interest on any development loan, arrangement, exit and monitoring fees, legal and valuation costs, and profit given up under forward funding or to equity partners. Interest usually rolls up over the build, so a longer programme or a slow lease-up adds to the total cost even if the rate does not change.

Arranging forward funding or a forward commitment can take several months, because the investor carries out its own checks on the site, planning, design, contractor and rental market before agreeing terms. Development loans for smaller schemes can be quicker, but still depend on valuations and reports being completed.

Planning the funding early, and keeping the build programme realistic, reduces the risk of needing extra finance late in the scheme, when terms are usually less favourable.