Ian Humphreys, CEO & Co-Founder of Brickflow gives his top 5 tips for property developers to manage risk in a volatile environment. Ian discusses using cash efficiently, phasing, forward sales, interest rates and renegotiating transactions.
- Cash is king
- Fixing interest rates
- Forward sales
- Renegotiate transactions
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When economic uncertainty sets in, projects become even more challenging for property developers. However, for many of us in the sector, stopping and doing nothing is not an option.
The most important skill in property development at all times is to manage risk. And this becomes even more important in times of volatility.
In any environment, by managing the risks you can control, this should reduce the impact of the things you can't control.
As an example, if you had employed a contractor with a weak balance sheet prior to Covid, then there would be a higher chance of that contractor going under when lockdowns reduced payment frequency on contracts.
Similarly, by not purchasing certain materials that could be paid for in advance when material costs were lower, would have also had an adverse impact on your profits.
These are examples of variables you can control.
The current market conditions are something you can't control, but if you have managed risk accordingly elsewhere, then the impact of these macroeconomic events could be reduced.
As someone remarked to me last week, their current policy is ‘proceed, but with caution’.
1. Cash is King
In any downturn it's important to have cash available. As a property developer, that is predominately reliant on property sales for income, when sales slow down that is a problem.
However, having cash available to take advantage of any reduced pricing of land in the next year or so, is key.
Arguably, the biggest cost for any property developer is opportunity cost. And there will be huge opportunities that will arise out of this downturn. So make sure you have cash available.
There will be a plenty of developers and investors raising money against residential properties, commercial properties and land right now, to make sure they have money available for when land prices fall.
You have a site, with planning, and you were ready to go and had everything mapped out ahead of you, and then the government’s mini-budget caused interest rates to spike and all of your plans are in disarray.
If you don’t start, economic conditions will worsen, and it could be 2-3 years before the property comparables and lending environment are better than where they are today.
And on top of that you don’t want to sit on your hands for 2 to 3 years.
Can your site be phased?
Deliver a smaller number of units first and see how the market reacts. If values are down on where you need them to be, then pause before starting phase 2.
If values are above where you expected, then deliver phase 2 quicker.
Phasing will normally increase your build and funding costs though, so make sure you crunch the numbers properly.
3. Fixing interest rates (if available)
The number of fixed rates available in the development finance space has fallen dramatically since interest rates started to rise.
Brickflow has 40+ lenders on the platform, and before the recent rises, around 20 would have offered some kind of fixed rate. That number is now less than 10 and falling every week.
Some lenders have priced up their fixed rates, so whilst they are fixed, the rate starts at 2% or more higher than the corresponding variable rate, so is it worth it?
Only you can make that decision.
Where do you think rates are going?
If they go higher than forecast, and / or stay higher for longer, what will that do to your project, and it’s profits?
Every developer should be stress testing the impact of increased borrowing costs on their project at land acquisition stage.
4. Forward sales
Most sites will have an allocation to a Housing Association.
Is there an opportunity to sell more units to a HA?
Could a build-to-rent operator be interested?
Can you make any off-plan sales?
Forward sales, normally involve an exchanged contract before construction starts, and some money paid over at that time. The so-called golden brick payment.
Development lenders love an element of forward sales, and will potentially lend at a higher leverage against those units that have been sold, bringing up the overall leverage against the site.
Before doing any deal though, make sure you’re dealing with reputable buyers - the lender will look at the covenant strength of the buyer.
How long have they been around? Are they financially sound?
5. Renegotiate transactions
The current economic situation is no secret. Any seller you're dealing with will be acutely aware of what is being forecast by the media, so use that to your advantage.
Explain to the seller that if the end values are now lower, that this translates to a lower buy price now.
And you can do this by showing them a residual land value calculation.
One way of negotiating a better price would be to offer an overage.
For those that don't know, an overage is a contractual obligation to pay a seller more for a site, if you achieve a greater value.
As an example, I'll agree to buy a site from you for £ 1m, as that’s because I believe I will achieve £ 5m in sales, and after all my costs that leaves me with a 20% developer profit.
You, as the seller, want more than £ 1m for the site as you believe the GDV is greater than £ 5m.
Therefore, me as the buyer could offer to split 50/50 any net sales revenue with you over and above £ 5m.
If the market is strong, you’ll get more money. If the market is weak, I’ve protected myself.
If you're looking for more information on development finance, for yourself or your clients, please get in touch - firstname.lastname@example.org.
Brickflow is designed to be used by experienced finance & property professionals and property developers using Limited Companies or Incorporated Partnerships, to source and apply for development finance loans.
Brickflow is not an advisory business and does not give advice. It can deal with purely factual inquiries and provide information but it will not give an opinion or recommendation in any circumstances.
Property development carries risk, including variables beyond the developer’s control. A property development loan is debt and should be procured with caution.
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