Development Finance for Conversions: Commercial to Residential Guide

Commercial-to-residential conversions occupy a favourable position in the development finance market because they typically involve less risk than ground-up development while still delivering strong returns. The existing building provides a physical asset that already has value, reducing the lender’s downside exposure compared to financing a vacant site where the only security during construction is bare land. The planning route for conversions, particularly through permitted development rights under Class MA, is generally faster and more certain than full planning applications, which reduces planning risk. And the end product, typically apartments in urban or semi-urban locations, benefits from strong rental and sales demand across most UK markets.

In our experience, conversion projects account for approximately 30% of the development finance deals we arrange, and they consistently achieve faster approvals and more competitive terms than equivalent ground-up schemes. A typical office-to-residential conversion in a town centre location with permitted development approval and a well-evidenced appraisal can complete from application to first drawdown in four to six weeks, compared to six to ten weeks for a comparable new-build scheme. The lender’s confidence comes from the tangible nature of the existing asset, the relative simplicity of the planning position, and the proven demand for the end product.

That said, conversions are not without risk, and lenders are alert to the specific challenges they present. Hidden structural issues, asbestos, inadequate floor-to-ceiling heights, fire safety upgrades, and the cost of achieving Building Regulations compliance for a residential use that was never intended when the building was originally designed can all create budget pressures. Understanding these risks and presenting a well-prepared application that addresses them proactively is the key to securing competitive finance terms for your conversion project.

The most common route for commercial-to-residential conversions is Class MA of the Town and Country Planning (General Permitted Development) Order, which permits the change of use from Class E commercial, business, and service use to Class C3 residential. Prior approval under Class MA is not full planning permission; it is a lighter-touch process that considers only a limited range of matters including transport and highway impacts, contamination risks, flood risk, noise impacts, natural light in the proposed dwellings, the impact on the sustainability of commercial services, and fire safety. If these considerations are satisfactorily addressed, the local authority must approve the application.

The advantages of the PD route for development finance are speed and certainty. A prior approval application is typically determined within 56 days, and the grounds for refusal are narrowly defined. This means the planning risk is significantly lower than a full application, where refusal can be based on a much wider range of considerations including design, scale, character, density, and neighbour amenity. Most development finance lenders treat prior approval under PD as equivalent to full planning permission for lending purposes, and some will even consider applications before prior approval has been determined, conditional on it being granted.

However, PD conversions have limitations. There are restrictions on the size of the building that can be converted, the minimum unit sizes that must be achieved, and the location of the building relative to certain designations such as conservation areas or areas of outstanding natural beauty. External alterations beyond what is reasonably necessary for the change of use are not permitted under PD, so if your scheme requires significant changes to the building’s external appearance, a full planning application may be needed. Where full planning is required for a conversion, the application process is more akin to a standard development finance application, with additional time and cost built into the programme.

Build costs for conversions vary more widely than for new-build development because the starting condition of the existing building introduces significant uncertainty. A well-maintained modern office building with good floor-to-ceiling heights, adequate natural light, and no asbestos might convert for £80 to £120 per square foot. An older industrial building requiring structural alterations, asbestos removal, new windows, and significant mechanical and electrical upgrades could cost £150 to £220 per square foot. The presence of asbestos alone can add £20,000 to £100,000 to the project cost depending on the extent and type of asbestos-containing materials.

Before committing to a conversion project, commission a thorough building survey from a chartered surveyor experienced in conversion projects. The survey should assess the structural condition of the building, identify any asbestos-containing materials, evaluate the condition of the roof, windows, and external envelope, assess the floor-to-ceiling heights on each level, identify any contamination issues, and provide an opinion on the feasibility of achieving Building Regulations compliance for residential use. This survey is not just for your benefit; it is a document that significantly strengthens your finance application by demonstrating that you understand the building’s condition and have factored the costs of addressing any issues into your appraisal.

Lenders pay particular attention to contingency allowances on conversion projects. While 5% contingency might be acceptable for a new-build scheme with detailed designs, conversions typically require 7.5-10% contingency because of the greater uncertainty about existing building conditions. If the building has not been fully stripped back to allow a complete assessment, some lenders will insist on 10% contingency regardless of the developer’s own assessment of risk. We advise clients to budget realistically for conversions, accepting that there will be surprises and ensuring the financial model can absorb them without threatening the viability of the scheme.

The standard finance structure for a conversion is similar to ground-up development finance: a facility covering the purchase of the building and the construction costs, with funds released in staged drawdowns as the works progress. The purchase element is typically advanced on day one, subject to the building being worth at least the purchase price, and construction costs are drawn down as the monitoring surveyor certifies completed work. Loan-to-GDV ratios for conversion projects typically range from 60-70%, consistent with new-build development finance.

For conversions involving an existing building with rental income, the finance structure may be different. If the building is tenanted and generating income, the developer may initially acquire it with a commercial mortgage and then refinance into development finance once the tenants have vacated and the conversion works are ready to begin. This two-stage approach is common for occupied office buildings where the conversion programme is dependent on lease expiry dates. The commercial mortgage provides income-backed funding during the holding period, and the development finance facility kicks in when active conversion works begin.

Where the developer already owns the building, the development finance facility may be structured to release equity from the existing asset. If the building is worth £600,000 and has no mortgage, the lender can advance funds against this value as part of the facility, providing the developer with cash to contribute to the construction costs. This is particularly useful for developers who have acquired commercial buildings at low prices and seen significant value uplift, as it allows them to access that embedded equity without needing to sell the property. We regularly structure facilities in this way for clients who have accumulated a portfolio of commercial assets that are ripe for conversion.

Fire safety has become an increasingly important consideration for conversion projects following the strengthening of Building Regulations in recent years. Conversions to residential use must comply with Part B of the Building Regulations, which covers fire safety, and the requirements can be onerous for buildings that were not originally designed for residential occupation. Common requirements include the installation of fire-resistant compartmentation between units, provision of adequate means of escape including fire doors and emergency lighting, installation of fire detection and alarm systems, and ensuring structural fire resistance meets the minimum periods specified for residential buildings.

For buildings above 18 metres in height, or those with seven or more storeys, the regulatory requirements are significantly more demanding. The Building Safety Act 2022 and subsequent regulations require these buildings to meet enhanced fire safety standards, including the appointment of a named accountable person responsible for ongoing fire safety management. The cost of meeting these requirements can be substantial, potentially adding £200,000 to £500,000 to the project cost for a larger conversion scheme. Lenders are acutely aware of fire safety requirements and will expect your appraisal to include a detailed assessment of the fire safety works needed and their cost.

We recommend engaging a fire safety consultant early in the feasibility stage, before committing to the purchase of the building. Their report will identify the fire safety works required, estimate costs, and highlight any issues that could make the conversion unviable. A building with a single staircase that cannot be modified to provide two means of escape, for example, may not be convertible to residential use regardless of the commercial demand. Including the fire safety consultant’s report in your finance application demonstrates due diligence and gives the lender confidence that fire safety costs are accurately reflected in your budget. For more on the documents needed, see our application checklist.

The exit strategy for a conversion project follows one of three main routes: individual unit sales, retention and refinance onto a buy-to-let or commercial mortgage, or bulk sale to an investor. The chosen exit strategy significantly affects the finance terms, as lenders assess the certainty and timing of repayment. Individual unit sales provide the most certain exit for the lender, as each sale generates cash to reduce the outstanding loan balance. However, the sales period introduces timeline risk, particularly if the market softens during the sales phase.

Retention and refinance is an increasingly popular exit strategy for conversion projects in strong rental markets. The developer converts the building, lets the units, and then refinances the completed development onto a term loan secured against the rental income. This approach works well for conversions in urban centres where rental demand is strong, such as city centre office conversions in Manchester, Birmingham, or Leeds. The refinance amount needs to be sufficient to repay the development finance facility in full, which requires the completed rental value to support the required loan amount at prevailing commercial mortgage rates and yields.

Bulk sale to an institutional investor or housing association is particularly relevant for larger conversion schemes of twenty or more units. Build-to-rent investors and housing associations are active buyers of converted residential stock, and securing a forward sale or framework agreement before or during the construction phase can significantly de-risk the exit. Lenders view forward commitments very favourably, and the presence of a contracted buyer may enable higher leverage or lower interest rates. We have arranged finance for conversion projects with forward sales to housing associations in London, the South East, and the Midlands, and the forward commitment consistently improves the financing terms. Submit your conversion project through our deal room for a tailored finance assessment.