Commercial development finance: funding non-residential schemes

What counts as commercial development

Commercial development is the construction or conversion of buildings that people occupy for business rather than to live in. It covers offices and business parks, industrial units, warehouses and logistics and distribution sheds, retail and roadside units, leisure and hospitality space, and the commercial floors of mixed-use schemes. The common thread is that the finished building earns its value from a business occupier, so the finance is judged on who will use the space and on what terms.

Mixed-use sits on the boundary and is the most common form we see: flats above ground-floor commercial, so the residential element is valued on sales comparables while the commercial element is valued on yield. Lenders underwrite the two halves separately and blend them, which makes it more complex to fund than straight housing of the same size. Student accommodation, care homes and build-to-rent blocks are also treated as commercial or operational assets, because they are valued on income rather than on unit sales. The finance is unregulated commercial lending secured by a first charge over the site, and our role is to introduce and arrange it rather than to lend, and we hold no FCA authorisation.

• Offices, business parks and workspace
• Industrial units, warehouses and logistics or distribution space
• Retail parades, roadside and trade-counter units
• Leisure, hospitality and food and beverage space
• Mixed-use schemes blending flats over ground-floor commercial
• Operational assets such as student accommodation and care homes

Why lenders underwrite commercial schemes differently from housing

A residential development is underwritten against sales comparables: the lender looks at what similar homes nearby have sold for, applies a discount, and lends against that gross development value. A commercial scheme has no such comparable, because the value of an office or a warehouse is not what the building would fetch as bricks and mortar but what an investor would pay for the income it produces. That single difference is why commercial development finance feels stricter than the housing equivalent.

Because the end value depends on income, the lender wants evidence of that income before it commits. A ground-up scheme with a signed pre-let to a national retailer on a fifteen year lease is a very different risk to a speculative warehouse built in the hope that an occupier appears. In practice a commercial appraisal turns on three questions the developer must answer early: who will occupy the building, on what lease terms, and what an investor would pay for that income. We shape a case around exactly those before it goes to any lender.

Pre-lets and pre-sales drive the funding

A pre-let is an agreement, signed before or during construction, under which a tenant commits to lease the finished building on defined terms. A pre-sale is the equivalent for a buyer, often an owner-occupier or an investor who agrees to purchase on completion. Pre-lets and pre-sales are the single biggest lever on a commercial development facility, because they convert an uncertain future income into a contracted one, and lenders reward that certainty with higher leverage and keener pricing on the rate.

The strength of a pre-let is measured by the covenant of the tenant, the financial standing of the business taking the space. A lease to a listed company or a government body is a strong covenant an investor will pay full price for. A lease to a new or thinly capitalised business is weaker, attracting a higher yield and a lower end value. Lenders read the covenant, the lease length, the rent free period and any break clauses, because each feeds directly into what the finished asset is worth.

End value from yield, not from comparable sales

The end value of a commercial scheme is calculated by capitalising the rent, meaning the annual rental income is divided by a yield to arrive at a capital value. A building let at 100,000 pounds a year on a 6 percent yield is worth roughly 1.67 million pounds, because an investor buying at that price would earn a 6 percent return. Move the yield to 7 percent and the same income is worth only about 1.43 million pounds. This is why tenant quality and lease length matter so much: they set the yield an investor will accept.

For the developer, profit in a commercial scheme comes as much from the letting as from the build, and two identical buildings can be worth very different sums depending on who occupies them and for how long. The valuation is also sensitive to market movement in a way housing is not, because yields shift with investor sentiment and interest rates. A red book valuation underpins the lender's view, and the loan is sized against that figure with a margin held back for the risk that yields soften before sale or refinance.

Structure and leverage on a non-residential build

Commercial development finance is structured much like its residential cousin: a facility drawn in stages against build cost and gross development value, released as a monitoring surveyor signs off each phase, with interest usually rolled or retained rather than serviced monthly. The difference is in the leverage. Because the end value rests on income that does not yet exist, lenders advance a lower loan to gross development value than on housing. Where a residential build might reach up to 70 to 75 percent of GDV, a speculative commercial scheme often sits lower, indicatively around 55 to 65 percent of GDV, and where exactly it lands depends on the letting position and asset class.

A strong pre-let pushes that leverage up, because the income is contracted and the exit is closer to proven, while a fully speculative scheme sits at the bottom of the range or below it. Lenders also cap loan to cost, the proportion of total build and land cost they will fund, which sets how much cash or equity the developer contributes. Every rate and leverage figure here is indicative and illustrative only and never an offer of finance.

Lenders publicly active in the commercial development market include Shawbrook, Paragon, United Trust Bank, Close Brothers, Together, Octane Capital and Atelier. They publicly operate in this market, their criteria change constantly, and nothing here is an offer or a quote for any of them. We place each case with the lender whose current appetite fits the scheme, and we never quote a rate on a named lender's behalf.

Exit routes when the building is finished but empty

The exit is where commercial development differs most sharply from housing, and it is this site's specialism. A residential scheme sells unit by unit, so cash comes in gradually and the developer clears the loan piece by piece. A commercial building does not: it is usually sold or refinanced as a single let investment, so nothing repays the facility until the letting is done. That creates a gap between practical completion, when the building is finished and the development loan falls due, and the moment an occupier is signed and the asset can be sold.

There are three main ways a commercial scheme repays. An investment sale sells the completed and let building to an investor at its capitalised value. An owner-occupier sale sells it to a business that will trade from it, often the strongest exit because it does not depend on investment yields. A refinance onto commercial term debt, a longer-term commercial mortgage or investment loan, repays the development facility and lets the developer hold the asset for its rental income. Which route fits depends on whether the developer wants to sell the profit or bank the income.

Where practical completion arrives before a tenant is signed, a development exit facility bridges the letting void. Raised at or close to practical completion, this bridge clears the maturing development loan and gives the developer time, indicatively 6 to 18 months, to secure a letting and then move to an investment sale or a term refinance without a forced sale. On a finished commercial asset the exit bridge is priced indicatively between 0.65 and 0.95 percent per month, undercutting the development finance it supersedes now that construction risk has fallen away. The full picture sits on our pillar page at /solutions/development-exit-loans/.

Speculative build versus a pre-let scheme

Every commercial development sits somewhere between fully pre-let and fully speculative, and where it sits governs almost everything about the funding. A pre-let scheme has a tenant, or several, committed before or during construction, so the income and the end value are close to certain and the exit is largely proven before a brick is laid. A speculative scheme is built without committed occupiers, on the developer's judgement that demand exists, so the income is a forecast until a letting is agreed after completion. Many schemes fall between, with an anchor tenant signed and the rest speculative.

Lenders treat the ends of that line very differently: a pre-let build attracts higher leverage, keener pricing and a smoother process, while a speculative build is fundable where the location and asset class are strong, industrial and logistics space has let quickly in many markets, but at lower leverage and wider pricing. The takeaway is to secure as much of the letting as possible before applying, because every pre-let signed moves the scheme up the leverage curve and closer to a proven exit. Where that is not possible, the exit plan has to survive a letting void, which is exactly where a development exit facility earns its place. Every number we weigh here is illustrative only, never an offer of finance.