The deal memo is the most important — but most overlooked — element for residential developers seeking finance. If you prepare a credible memo upfront, the whole process suddenly becomes more efficient, plus you reduce the risk of overpaying.
Here are five essential steps for creating a deal memo that puts you in a strong position.
1. Validate your build costs
This is generally the easy part, and you commonly see build costs broken down in the rough appraisal spreadsheets SME developers typically prepare. But to get the right funding quickly, you need to go a step further.
Test your costs with other local contractors. Use BCIS (Building Cost Information Service) to calculate build costs per square foot in your market. That way you have a realistic estimate for your spend on total square footage.
Then there are the professional fees throughout the project lifecycle. This includes quantity surveyors, project managers, architects, lawyers, valuers, loan monitors and insurance. To get an appropriate funding offer, you need to factor in all these elements.
2. Calculate your scheme’s affordability
Your funder needs to know the market can afford what you’re building. This is essential knowledge for you as the developer, too, and it’s best to have complete visibility up front.
Don’t justify your price based on your costs — start with what the market can afford and work backwards from that. Think like a buyer. What can an average person afford in your market? How much of a mortgage can they get from the bank with Help to Buy? Use private and public data to look at the market demographics, including median household size and income.
This isn’t a full feasibility study; it’s an indicative market analysis that goes straight to the scheme’s viability — and helps ensure you get finance at the right price.
3. Analyse market trends and comparables
What’s been on the market recently? How long have properties in your price range been for sale? What are average per square foot sales? You and the funder need to understand the comparables.
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Also, what’s in the pipeline? Look at planning portals to see how many people have put in permissions in your area. You don’t want your project to hit the market at the same time as four competitors.
4. Define your exit strategy
The information you’ve compiled on affordability and comps will inform this. But you also need a plan B in case you can’t sell the units. That means looking at rental data and figuring out what your return is going to be. And it means considering your ongoing finance options given the rental value.
5. Understand your financing costs and underlying assumptions
Developers often assume someone else will cover the finance side for them. (Yes, this is something we help developers with all the time, in addition to the other four elements I’ve mentioned.)
Even if you have help compiling this information, it’s crucial you understand it. This includes the assumptions on how the equity and debt stack will work, and what the associated costs will be. What’s the cost of equity vs the overall weighted average cost of capital? What proportion of the project will the equity provider get? Will there be a coupon or not?
You need to understand all this in order to calculate your returns.
The final tip: Don’t be intimidated — it’s easier than you think
Collating all this information doesn’t sound easy — I recognise that. It’s why the standard approach is to compile that standard development appraisal spreadsheet with rough costs and let the funder take it from there.
But there are two issues with this:
- you, as the developer, need this information as ammunition — it ensures you can champion your own interests and get the best funding package
- it can take six to eight months of back and forth for the funder to get everything they need — which means frustration, delays and extra costs for you.
Compiling a deal memo with these five elements will save you time and money in the long run. Plus, you’ll have the confidence that comes from knowing you’re in a strong position to realise your investment goals.