An Agreement in Principle (AIP) can be one of the most encouraging stages of a development finance application. It provides an indication that a lender has an initial appetite for a proposed scheme and gives developers a starting point for assessing leverage, costs and project viability.
What an AIP does not provide is certainty as before funds can be drawn, the transaction will typically pass through valuation, Quantity Surveyor (QS) review, legal due diligence and full lender underwriting. As those stages are completed, the assumptions supporting the original proposal may change, sometimes materially.
A revised valuation, higher build costs, additional contingency requirements, changes in lender appetite or a different view of the proposed exit strategy can all affect the amount available, the structure of the facility and the level of capital required from the borrower. Site-specific due diligence can introduce further requirements, from mining or ground-stability reports to flood-risk, drainage, contamination, ecological, archaeological or other environmental assessments. In some cases the impact is relatively minor. In others, additional reports, remedial works or professional costs can affect the programme or funding requirement, while changes to the lending position may require developers to revise the structure, contribute additional equity or find a replacement lender before the project can proceed.
This article explains why development finance can change between AIP and drawdown, the areas most likely to affect a facility during underwriting and the practical questions developers can ask themselves to avoid unexpected funding challenges as a project progresses.
A recently completed £2.8 million commercial development finance transaction arranged by Finspire Finance provides a useful example of how these issues can arise in practice, which you can read about here. The project encountered several challenges that are common in development finance, including changes to lender appetite, valuation assumptions and capital requirements between the initial AIP and completion.
The purpose of this article is not to suggest that every development will encounter the same issues, as every case is unique. Rather, it is to demonstrate how development finance structures can evolve as assumptions are tested and to help developers prepare for the possibility of change before they commit significant time, cost and capital to a project.
An AIP is based on assumptions
An AIP is useful because it shows that a lender has an initial appetite for the proposed transaction. It is also based on information that has not yet been fully tested, so it is not a guarantee that funding will complete for the project.
The valuation may still need to be completed or refreshed. A QS may have to review the build costs, programme and contingency. Lawyers will examine title and security. The lender may ask for further evidence around borrower experience, proposed occupiers, sales assumptions or the exit. Any one of those workstreams can change the numbers used in the original proposal, often significantly.
In one recent transaction led by Finspire Finance, the QS increased the contingency allowance from 5% to 10% after the AIP had been issued. As the lender moved through its due diligence and underwriting process, it sought additional comfort around the fact that this was the borrower’s first commercial development, and the higher contingency increased the amount of capital required within the overall funding structure, this caused a problem for the client which was resolved promptly by Finpsire Finance connecting them with an investor that could provide the increased capital requirement.
Additionally, before approaching Finspire, that same borrower had encountered a separate issue with an earlier lender. That lender had also issued an AIP, but later withdrew following the QS review. Finspire was not involved in that original application, but was subsequently able to take over the case and introduce a lender whose appetite was better aligned with the borrower, construction method, construction materials being used, and development being proposed, and which was prepared to assess the wider merits of the transaction.
For borrowers, the wider point is that an AIP should not be treated as the definitive approval that a project will be successfully funded. It is worth considering what would happen if the lender later changed its position for an unforeseen reason, whether another suitable funding option exists, and how quickly that alternative could be put in place. Where a development is already incurring professional costs or moving towards construction, delays can create financial and operational pressure. This is one of the areas where an experienced broker can add practical value by knowing which other lenders may be suitable and what parts of the structure can be adjusted if the original route stops working.
Lender appetite is part of the structure
Development finance is often compared through rate, fees and maximum leverage, but those measures only describe part of the funding proposition. Construction method, asset type, geography, borrower experience, owner occupation and the proposed exit can all affect how a lender views a scheme.
A lender may still be prepared to issue an AIP where part of a transaction sits outside its normal appetite. At that stage, the initial information may be strong enough for the lender to consider whether the wider deal justifies an exception to its usual mandate. The transaction can then move into valuation, QS review, borrower due diligence and full underwriting before the lender reaches a final credit decision.
If those later stages confirm that the project presents limited risk, the lender may be comfortable progressing despite the transaction sitting outside the centre of its usual lending profile. If the due diligence introduces additional areas of concern, however, a deal that initially appeared capable of fitting within appetite may no longer justify that exception. This is not unusual in development finance, and it does not mean the AIP was issued incorrectly. It reflects the fact that an AIP is based on limited information, while the final decision is made after the lender has had the opportunity to test the assumptions behind the transaction in detail.
For developers, the difficulty is that lender appetite is not always obvious or may have been communicated poorly from the outset. Two lenders may both advertise development finance at similar leverage levels while taking very different views on the same construction method, borrower profile, location or exit. Understanding those differences across the wider market is also an unreasonable expectation to place on a borrower whose day-to-day role is running a business or delivering a development rather than tracking lender mandates.
That is why lender selection should go beyond asking who is willing to issue terms. The more useful question is why a particular lender is being approached for that specific scheme, how closely the transaction fits its established appetite and which parts of the proposal are likely to receive greater scrutiny once underwriting begins.
This is one of the areas where an experienced broker can materially reduce execution risk. A broker who understands how different lenders assess similar transactions can direct the application towards funders whose appetite is more closely aligned with the project, while also retaining alternative routes if the original structure changes after AIP.
Stress-test the valuation before it arrives
One of the more common structural risks in development finance is that the eventual valuation does not match the number used in the original appraisal.
This does not require a dramatic fall in value to matter as development facilities are usually constrained by more than one measure, so a relatively modest valuation movement can change the amount of senior debt available or the cash contribution required from the borrower.
On a recently completed Cornwall project by Finspire Finance for Krev Performance, the refreshed valuation moved from approximately £2.885 million to £2.775 million following an increase in local yields. Combined with the terms of the replacement facility, that contributed to an additional capital requirement of approximately £200,000.
For another development, the numbers will be different, but the planning exercise is the same principle. If a project only works when the valuation lands exactly on the developer’s expectation, there is very little room for the funding structure to absorb change.
Before relying on the proposed facility, developers can model a small number of downside cases. A valuation 5% below expectation is one. A higher QS contingency is another. It may also be worth considering the impact of additional professional costs, delayed completion or a lower level of senior leverage.
The purpose is not to predict what the valuer or QS will do, as this is impractical. It is to quantify the amount of additional liquidity that would be required if the original assumptions are not confirmed and to assess whether the deal can move forward if assumptions change and understand whether you have a plan ready if that issue arises.
Retain liquidity where the project allows it
Land is often the first major capital commitment in a development. Paying for a site outright can strengthen the borrower’s position, but it can also leave less liquidity available if the development facility later changes.
In the Cornwall transaction for Krev Performance, the borrowers had already committed their available capital to the land. When the revised funding structure created an additional requirement of approximately £200,000, another source of capital was needed alongside the senior facility. Finspire Finance introduced the borrowers to a private investor it had worked with previously, after which the parties negotiated the investment terms directly.
Blake Bull, Director at Finspire Finance, described the capital requirement as the main threat to the project proceeding:
The biggest threat wasn't the lending, it was the capital contribution requirement. You can structure lending and find a lender who is comfortable with the project and the team, but if the borrower has already deployed their capital into the land, that remaining gap still has to be funded or the transaction cannot proceed.
James Earp, the Founder and Co-owner of KREV Performance said:
After the land was valued lower than expected, we faced having to find more than £200,000 of additional contribution. That was another major change to the position we had been working towards. We turned to Finspire, who were able to introduce us to an investor, and we agreed a structure that allowed the project to continue.
The lesson for other developers is not that private investment should be arranged behind every development facility, this was a specific hurdle that arose on this particular deal. The lesson here is that the borrower should know what liquidity remains after land, professional fees and the expected equity contribution have been paid.
Where there is little remaining headroom, it is worth considering in advance what sources of additional capital could realistically be available. Depending on the project, these might include shareholder funds, another investor, subordinated finance, the sale or financing of another asset or amendments to the development programme. Each has different commercial and legal consequences and may require the senior lender’s consent.
Do not treat every lender condition as the same problem
A development facility brings together several separate forms of risk. Property value, build cost, borrower contribution, guarantees, development experience and exit all affect the lender’s assessment, but they do not necessarily reinforce one another in a simple way.
Additional capital may address a cost-to-complete requirement without changing the lender’s position on guarantees. Stronger security may give the lender comfort in one area without replacing a required borrower contribution. Introducing another investor may resolve a commercial funding issue while creating documentation or consent requirements elsewhere.
The practical approach is to understand what each condition is intended to address. That becomes particularly important when the structure changes during underwriting, because one amendment can have consequences for the legal documents, security ranking or other professional workstreams.
This is also why detailed lender-specific credit discussions should not be reduced to a generic rule. The appropriate structure depends on the project, borrower and lender involved.
Evidence matters more than labels such as 'first-time developer'
Borrower experience is another area where the initial description can be misleading.
Someone undertaking a first commercial development may still have residential development experience, an established operating business, a project manager, experienced contractors and sector-specific knowledge. Another borrower may have completed previous developments but be moving into a construction method or asset class that is new to them. Lenders need evidence that allows them to assess the team actually delivering the project.
On one development that Finspire completed, the borrowers had residential development experience and one director ran a project management business, but the scheme was their first commercial development of this type. The client also intended to occupy around half of the space themself, with the balance made available to third-party occupiers.
A meeting with the lender allowed the borrowers to explain their operating experience, delivery capability and plans for the building directly. Evidence of occupier demand supported that discussion. The QS had estimated annual rental income of approximately £240,000 for the relevant space, while interest from eight prospective tenants indicated aggregate rents of around £280,000 a year.
For another developer, the evidence will depend on the scheme. It might include the track record of the contractor, project manager and architect, previous developments completed by members of the team, Heads of Terms from prospective tenants, pre-sales, comparable rents or evidence that the trading business can support owner occupation. The aim is not to describe the management team as capable; it is to provide information from which the lender can reach that conclusion themselves.
Treat the exit as part of the finance application
Borrowers should remember that development finance is short-term capital. The route out of the facility therefore matters from the beginning, whether the plan is to sell the completed development, refinance it or use a mixture of both.
A build-to-sell project needs assumptions around sale values and the time required to complete disposals. A retained investment needs rental assumptions that can support longer-term refinancing. An owner-occupied property also requires consideration of the underlying business and the debt it will need to service after completion.
A useful exercise is to work backwards from the proposed exit. If the completed debt is to be refinanced, what level of rental income and value would support that borrowing? If units are to be sold, how dependent is the repayment of the development facility on completing those sales within a particular period?
An exit should be evidenced to the same standard as the development appraisal rather than treated as something to solve at the end of the build as it is fundamental to the application.
Coordination becomes more important when assumptions move
A development facility can involve the borrower, lender, QS, valuer, lawyers, architect, contractor, project manager, investor and other specialists. Each is looking at a different part of the transaction. Therefore, the need for coordination becomes most apparent when one of the original assumptions changes. A lower valuation may affect available debt. That can alter the borrower contribution. A new source of capital may require legal documentation and lender consent. A change to the build programme can affect the QS, interest calculations and completion timetable. No single professional automatically owns all of those consequences.
Curtis Bull, a director at Finspire Finance, described the role of an experienced broker in those circumstances as identifying the commercial constraints facing each party and structuring a transaction that remains workable for the lender, borrower and wider professional team.
The broker’s role is not simply to find another lender or negotiate harder on price. It is to understand what is driving each party’s position, whether that is leverage, valuation, security, timing or deliverability, and then determine where there is enough flexibility to construct a viable solution for all parties. Once that structure is agreed, the solicitors, investors, QS firms and valuers all need to be aligned so that it can actually complete.
This is also a useful way to assess a broker or adviser before instructing them. Access to lenders matters, but complex development finance can require work after the lender has already indicated an appetite to lend. Understanding valuations, QS reports, additional capital, security, professional dependencies and the proposed exit becomes more important as the transaction moves towards drawdown.
Questions worth answering before a developer relies on an AIP
Development finance can change materially between AIP and drawdown because the assumptions behind the original proposal are still being tested. Valuation, QS findings, lender appetite, borrower contribution and the proposed exit can all alter the structure before funds are available.
The practical question for developers is therefore: are you prepared if one of those assumptions changes? Before relying too heavily on an AIP, there are several questions worth answering.
- What assumptions determine the proposed facility amount?
- Which of them still need to be tested by the valuer or QS?
- How much liquidity remains after the site acquisition and initial costs?
- What happens to the required contribution if the valuation falls short?
- Does the proposed lender have experience with the construction method and asset?
- What evidence supports the development team’s capability and the anticipated rents or sales?
- What is the realistic exit?
- And if the structure changes, who is responsible for understanding the consequences across the lender, lawyers and professional team?
These questions are not an exhaustive pre-application checklist, but they do help determine what kind of support a developer may need once the transaction moves beyond the AIP stage. Where funding depends on several assumptions remaining aligned, the value of the broker is often in continuing to manage the transaction as those assumptions are tested.
James Earp, the Founder and Co-owner of KREV Performance said:
Our broker was the most important cog in this wheel. Having him by our side all the way to the end was paramount to seeing this through. There are so many intrinsic small parts within deals, and a broker who can adapt as those issues arise is worth their weight in gold. We would tell another developer not to assume the broker’s role ends once terms are agreed.
That experience reflects the wider point of this article. Development finance will always involve assumptions around value, build cost, lender appetite, borrower contribution and exit. Those assumptions cannot all be fixed at AIP stage, so developers need to understand which ones matter most and what options remain if one of them changes.
This is the role a good broker takes on for property developers: assessing the structure before an application is submitted, identifying lenders whose appetite fits the project, and remaining involved through valuation, QS review, underwriting and drawdown. For businesses considering a development, or dealing with a transaction that has changed after AIP, that means having a broker who can help identify what has moved, what alternatives remain and how the funding structure can be revised without losing sight of the wider project.
