Industry Insights (Q3 2021): the inside track of what we’re seeing in property development

For more news and views find us on LinkedIn, Facebook or Twitter @brickflow

 

 

Squeeze me

The huge increase in material costs has been well-publicised and it’s true to say that if you haven’t planned for this change in circumstances it can and will have a disastrous impact on your bottom line.

Lenders (and their professionals) are acutely aware of this, and want to see developers have made contingency plans. Whilst we’ve (hopefully) seen the end of anything as disruptive as a lockdown, but as we saw in the Suez this year, there are unknowns you simply cannot legislate for.

 What happens if your windows take an extra six weeks to be delivered, or your kitchens get stuck on a boat for months? What happens if your labour costs go up by 15% due to staff shortages? These are all things lenders want to see that you have thought about. The pre-pandemic standard of a 5% contingency and a three month sales period are not coming back anytime soon (or ever). 

 Higher contingencies and longer sales periods do translate to lower day one loans and larger deposits, so borrowers are keen to avoid them; but it’s better than the alternative of being short on money or time, as you near PC.

 As well as material costs, developers also have to contend with increased competition, and changes to business models. We’re regularly seeing borrowers being outbid on sites by quite astonishing amounts. 

 It’s always been the case that a builder can outbid a developer on smaller sites, due to their ability to build cheaper, however, we’re seeing bidding wars on much larger schemes as well.

 Housing Associations will always be difficult to match when you have to go to best and final bids, but we’re also seeing institutional investors coming into the much vaulted PRS / BTR sector in a big way. These businesses are happy to build for much smaller profit margins, perhaps 5% to 10%, or in some cases even come out flat, as they look to make their money from future tenancies.

 We’ve seen instances where borrowers have made full bids on sites beaten by more than 50% – one bid of £ 1.8m (which left the developer with only 17.5% post-finance) lost out to a winning bid of £ 2.8m – it’s like trying to compete with Manchester City in the transfer market.

Beware “property gurus”

Property development is hot at the moment, and there is a lot of interest from ‘non-developers’ to get into the space, which is great for the economy and our ongoing housing shortage. However, please research these property development courses carefully.

I have spoken to some users who have been on these so-called mastermind courses, and I’ve been surprised by the utter rubbish that has been fed to them, especially when it comes to financing a property development. Thankfully, they seem to be a minority (some courses seem to be very good!).

If you’re a first-time developer, there is almost zero chance of a lender funding you on a new-build scheme on your own. The only way you will do it is if; 

  1. You have a very strong balance sheet and therefore your PG is worth something
  2. You are a construction professional or have one alongside you as a shareholder (ideally a builder or QS / PM with relevant experience)
  3. You have a big enough deposit to be only borrowing a small amount of the overall GDV

In an ideal world, it would probably be a combination of all three.

One recent user, a person that was borrowing all of the deposit from the family, had never worked in construction, had little to no PG strength, was surprised to learn that no one wanted to fund him for a scheme of six new-build houses. When a lender suggested that bringing a builder in to take a 20% profit share might help, it was instantly dismissed as his ‘how to be a property developer’ course (that he’d paid thousands of pounds for) had told him never to collaborate with a builder – madness.

We have seen borrowers graduate to new-build from PDR & conversions (again with the right team around them), but previous projects need to be of a good size – and the more the better. A loft conversion and splitting a house into 2x flats, will not mean a lender backs you on 6x new-build houses. Converting a house into 4x flats and then an office building into 12x flats (perhaps with adding a floor or an extension) is more likely to yield you a better outcome when you look to graduate to new-build.

PDR – a wonderful opportunity?

 As class MA and other incentives come into effect, especially in a post-Covid environment, there’s no denying there are some excellent properties that can now be converted to residential. Think of the wonderful architecture lining a lot of city centres, with high ceilings and instant access to amenities. A beautiful place to live.

 However, please remember that just because a property can be converted to residential, it doesn’t mean it should be.

 Rightly so, lenders are increasingly wary of lending on any old PDR scheme. Minimum spacing standards have helped, but location is still most important. We’ve seen opportunities opposite bus depots, or on the edge of (or even in), industrial estates. These are not properties you will get funding for readily.

 If the exit strategy is to let the units, then lenders may be more flexible. Tenants will be more tolerant of their surroundings than buyers. However, lenders still like to know that in a worst case scenario, what you’ve built is liquid enough to dispose of quickly and easily through sales.  

 A low rise office block being converted into flats, with no outside space or balconies, next to an abandoned bowling alley and some vacant offices and retail units, is not what buyers (or lenders) want.

Whilst we’re on the topic…

We can see any company that manufactures safe, cheap and easy to install balconies to go on the side of glass office buildings doing extremely well over the next few years 😉

Commercial property

 We’re pleased to say the appetite for commercial property lending is coming back with some lenders. As a rule, only around 15%-20% of the development finance market would lend on pure commercial property pre-Covid, and that pool of lenders almost disappeared entirely last year and the early part of 2021. The only real exception is logistics space, which is about the only commercial space that can currently be funded on a speculative basis.

As activity has picked up again in the office and hospitality sectors, lenders are once again interested. Again, the lead time for property development helps. Lenders are funding opportunities that might not be delivered for two years, so the current environment will hopefully be a distant memory. 

Given the exodus from London, regional hubs certainly look like a good bet. You can easily see companies downsizing in London as staff only come in two-three days per week and then perhaps require smaller serviced office space required in the south-west, home counties and Suffolk.

Remember, you will almost always need a pre-let or pre-sale on any commercial space. Retail is still very challenging, and unless you have a very strong and established brand (probably a food retailer), then don’t bother trying to get funding.

 Mixed use schemes are also suffering, as most lenders will ignore the value of the commercial units entirely, bringing down the overall GDV, and therefore the lending value of the scheme (meaning bigger deposits are needed to get the scheme off the ground). At best, without a pre-let or pre-sale, for a well-located site you may get a lender to use the VP value of the commercial element.

 

Development finance has never been better

 

As 2020 was a write-off for many lenders, it’s true to say that 2021 has seen most lenders come back into the market with a vengeance.

Whilst commercial property still has its challenges, the residential space is booming. Missed lending targets last year have been smashed this year, as lenders make hay.

There are also a lot of new entrants to the market. Large American and Pan-European funds aren’t just coming in on the buy side (as I talked about earlier in the article), they are also dipping their considerable toes into the UK market, buoyed by both the ongoing housing shortage and strong government support for the sector.

Whilst we have seen some pricing decreases, the increased competition has probably led to more risk taking; marginal deals and higher leverage, rather than a race to the bottom as there doesn’t seem to be room for funding costs to drop much further.

We predict a very strong and healthy 2022, with plenty of funding support for the right schemes and continued state support through planning reforms and government equity loans.

 

You can’t plan for delays

The one fly in the ointment impacting almost everyone is planning delays.

Planning decisions are taking three or four times longer than they would have done pre-Covid. A combination of staff shortages and working from home on the council side, and changes to planning laws and high demand on the other side, have seen planning decisions move to unprecedented timescales. 

Councils are targeted to return planning decisions within eight weeks of acknowledging a new application. When I’ve submitted planning applications myself, I’ve received my acknowledgement the same week – however, we are speaking to people that haven’t received their planning acknowledgements for three, four, five or even six months. So, what should be a two-to-three-month process, is taking up to nine months for many applicants. 

Even once you have your planning consent the delays don’t stop there. Discharging the conditions can take weeks and months longer than it should due to the backlogs.

As a result, borrowers that thought they’d be on site in summer 2021 are now going to be lucky to get on site before 2022.

Last orders

 In light of the above, and whilst it might seem strange to think about it, when we’ve barely had a summer, we’re coming to that point in the year when developers need to start deciding whether to get on site in 2021 or wait until 2022.

 No one draws loans down in December and the last two weeks of November aren’t most people’s favourite time to draw either, so technically there are only about 14 weeks of the year left.

 Most development finance applications will take 8-10 weeks. They can be completed  quicker, but can also easily take longer with the  council and discharging planning conditions’ delays, so please bear that in mind when thinking about timing.

 If you want to get on site this year, then please get in touch ASAP.

Want to stay in the loop? Sign up to our mailing list

If you found this article and think your friends or colleagues would find it useful, please share with your network.