Forward funding agreements (also known as Development Finance Agreements) are entered into when someone financing the construction of a building offers interim financing to enable development to occur. It enables investors to receive a fixed rate of return on their investments. On completion, the buyer makes a final balancing payment based on the property’s worth, deducting the value of any previous payments. Due to the fact that Stamp Duty Land Tax is assessed on the value of the undeveloped site rather than the value of the built-on land, the tax obligation is lower than in a typical transaction.
In this article, forward funding agreement, we take a look at the process involved.
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What are the advantages of a Forward Funding Agreement?
Title certainty
By paying for the land and acquiring title ownership in advance, an investor mitigates the danger of a third party asserting ownership contrary to the developer’s during the construction phase. Additionally, by mandating the removal of any charge on the land as part of obtaining ownership, a forward fund investor can eliminate the developer’s lender position.
In a forward sale, the developer’s lender will seek to maintain a strong presence throughout the process, whether through the appointment of a professional team to manage the transaction or the establishment of various step-in agreements and/or a duty of care agreement. In a forward fund, the investor’s lender (if any) will play a significant role. This benefits the investor because there is a strong likelihood of a shared objective between the investor and the investor’s lender. This objective is to secure a completely established and functional site in order to facilitate a long-term partnership. By contrast, the developer’s lender’s main concern will be the repayment of the cash advanced.
Finance risk
From a developer’s perspective, the primary advantages of the forward funding structure are that it provides significant cash flow from the early site sale, certainty of development finance for the project, and a more balanced approach to risk than the forward sale, where the developer bears the majority of construction risk. Because the investor acquires the land at the outset and then funds the construction works in real time through a development funding agreement, the developer and investor share the development risk.
Investors are likely to be less concerned with the risk associated with ongoing finance requirements during the construction process in this period of relatively low capital costs. Additionally, where an income fund investor is involved, the developer will very certainly be forced to pay a percentage coupon on the advance of building costs, which, unlike a forward sale, allows the investor to earn money during the development process.
Mitigation of SDLT
Stamp duty is payable on the whole price of the site and finished works in a forward sale, as well as any increase in stamp duty rates that may occur between contract signing and completion.
While many investors are drawn to the potential stamp duty savings associated with forward fund transactions, particular tax guidance should be obtained for each transaction to guarantee compliance with revenue requirements.
Investor Returns
For the investor, forward funding is expected to deliver larger returns on the investment because it allows for the acquisition of the development at a higher initial yield than would be feasible through a forward sale. Additionally, it will have greater negotiating leverage when it comes to tailoring the plan to the investor’s specific needs.
What are the disadvantages of forward funding for purchasers?
Buyers must exercise caution when dealing with forward sales that appear to be forward funding agreements. Whilst a forward sale is a valid transaction structure, it lacks the tax advantages associated with a forward funding arrangement. An experienced property solicitor will be able to advise you on whether a forward funding agreement is the most advantageous form for your purchase.
It’s worth noting that certain forward funding agreements encounter difficulties when developers fail to meet their promises, which is why it’s critical to have contingency measures in place.
What are the disadvantages of forward funding for developers?
The primary downside of forward funding agreements for developers is that while the final price is fixed, interest rates and development costs might change during the duration of the project. As a result, developers may suffer financial losses if the price agreed upon prior to the transaction does not cover the whole cost of development.
How we can help
We have a proven track-record of helping clients draw up forward funding agreements. We are a multidisciplinary firm and have all the expertise inhouse to satisfy the most exacting requirements of our clients. We will guide you through all the necessary legal due diligence in a comprehensive and timely manner. We firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
How to Contact Our Commercial Property Solicitors
It is important for you to be well informed about the issues and possible implications of signing a forward funding agreement. However, expert legal support is crucial in terms of ensuring a positive outcome.
To speak to a member of our New Enquiries Team today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
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