In the first part of this article, I talked about the general disruptions that both the housing and property development finance sectors are currently facing due to COVID-19, with a particular focus on which actions to take to mitigate this where construction is in progress.
But as the economy opens up and lockdown restrictions are eased or erased altogether, what will these markets look like?
What will the Housing Market and the Property Development Finance market look like as we come out of lockdown and open up the economy? What opportunities will surface?
Whilst lenders, developers and associates will, overall, work through the construction element of the cycle, what is unknown is the impact that the disruption from COVID-19 will have on-demand for residential housing and at what price. In other words, will house prices fall, if so by how far and how quickly?
There are lots of opinions in the ether ranging from minimal to armageddon but in truth, it is an unknown. The status of the Property Development Finance & Bridging market will, to some extent, be shaped by the outturn of asset values. If prices drop significantly over a short period, some developers and lenders will lose money, and this will result in withdrawal from the market. Lenders that are heavily exposed with highly leveraged projects or that have made poor lending decisions may struggle. As will those with liquidity issues.
Anecdotal evidence of lenders withdrawing from the market and reducing LTVs suggested that the Development Finance market had significantly contracted, which has now been confirmed in a report by CBRE. Some lenders will not return and others will have reduced capacity and appetite.
The fundamentals of the housing market remain strong. There is a shortage of supply and ‘generation rent’ are desperate to get on the ladder. Interest rates, and thus mortgage rates are at an all-time low. The banking sector is liquid (unlike 2008) with suitable capital reserves to withstand economic shock and £ Sterling, and thus UK property is attractive to overseas investors.
However, pushing against this is the inevitable recession which is likely to result in an additional million or so being added to the dole queue. The cost to the Government of supporting the economy through the crisis will add eye-watering sums to both the debt and deficit. To put it in perspective, the world central banks have put significantly more into QE since lockdown than in the financial crash of 2008.
It is not yet known whether we will have a V, U, L, or another shaped recession, nor the resulting outturn of Government debt. How will the Government fund the public purse (increased taxation/austerity/borrowing) and how will this impact on disposable incomes?
Putting aside economics, sentiment will be a driver, certainly in the short term. Redundancy or fear of it. Fear of a second wave of COVID-19. Sellers will be wary of selling at a discount, and buyers will be wary of buying an asset which may drop in value. Early data on activity reflects pent up demand, with Knight Frank reporting accepted offers since the lift of lockdown up 52% on the five year average outside London and 35% within London. On prices, Nationwide Building Society report a drop of 1.7% May on April and 1.4% June on May, with annual house prices dropping by 0.1%, the first drop since 2012.
Perhaps we are in the twilight zone; straddled either side by the light of the upturn in activity and the gloom of the pending recession.
Against this economic background what appetite will Development Finance & Bridging Lenders have in the next 6 Months?
Well-funded lenders, with clean lending books, will support applications from experienced developers with well-located, designed and profitable projects in the appropriate target markets. For example, family housing in the Help To Buy price range. It remains to be seen whether the much-mooted move from the hustle and bustle of the city to the peace and tranquillity of the suburbs transpires.
LTVs will be moderate until the outturn of property values is known or stabilises. Cash will be king and highly leveraged debt and equity will be in shorter supply. With senior debt lenders withdrawing or reducing LTVs, mezzanine finance will be in vogue.
Lenders will apply robust contingencies to construction costs, the build programme and extend sales periods. Therefore, we can expect up to 3-6 months to be added to a typical 15-18 month project.
Until valuers have robust comparable house price data they are likely to continue to include the ‘material valuation uncertainty’ clause. If larger developers sell substantial stock at a discount, this will result in lower average sales price data.
The result of these market adjustments is that the developer will need to invest more cash into the project than they had anticipated prior to the pandemic. All in all, pricing may rise slightly to reflect the perceived risks and we may see Fintech playing an ever-widening role.
What opportunities will exist as the market opens up and what strategies are relevant?
The outcome is likely to be a buyers’ (developers) market. With enforced additional costs in construction and finance and with uncertainty over sales values, developers should work on higher margins. This should lead to a reduction in land prices.
Look out for distressed assets that will come to the market. Seek joint ventures with landowners, and secure sites on subject to planning options or contracts. Incentivise sellers to agree to defer part or all of the land purchase price until post-construction and sale of assets. This will deleverage the finance, reduce finance costs, improve profitability and reduce the risk to both the developer and the lender.
Aim to structure projects with less debt and more equity if possible. If developer equity is limited, bring in third-party investors. Whilst this may be more costly overall, it will lessen the risk of the project and reduce finance charges, providing flexibility in the event of slow sales. Always pre-sell off-plan where possible and consider deploying a sales underwriting strategy so that any unsold units are pre-sold to a third-party.
Commercial property prices are likely to fall with business failures, particularly in retail and hospitality, resulting in vacant town centre premises. This will provide opportunities to convert this commercial space to residential, under both PDR (Permitted Development Rights) and planning consent.
With limited space for new residential development in urban areas, attention is turning to building on top of existing buildings and the government is due to introduce PDR (Permitted Development Rights) for airspace. There is potential significant opportunity here.
Government Policy on Housing
The Government is under siege from numerous industries (airline, retail, hospitality etc.); housing is in the queue and three recent announcements have caught they eye:
Stamp Duty – the raising of the threshold from £125,000 to £500,000 on residential properties with immediate effect is most welcome.
CBILS for Property Developers – The CBILS scheme whereby the government guarantees 80% of the debt and covers finance charges for 12 months, is now available to property developers from a handful of lenders. For both the construction and sales phase.
Planning Reforms – Robert Jenrick, the Housing Minister is undertaking what appears to be, a radical review of planning policy. Ideas being mooted include removing some decision making from local councils and putting it with central government, zonal planning and deregulation of use classes, amongst others. A policy paper is due this month.
Successive governments have failed dismally to address the housing shortage and radical supply side strategies are required. With the importance of housing and construction to post pandemic economic recovery, perhaps this is time for the government, with its 80 majority, to take on nimbyism? New Garden Cities anyone?
Other ideas doing the rounds include:
- Extending Help to Buy for two more years.
- Reintroducing the Help to Buy Mortgage Guarantee scheme
- Extending unimplemented planning permissions by a year.
- Relax – reduce statutory payments such as s.106/CIL.
- Government to JV with House Builders by providing land at nil cost.
- Government to forward purchase housing stock to be re-sold to buyers upon occupation.
The house building and associated finance industry face interesting if challenging times, but with significant opportunities.
At Optima, we broker Development Finance in the Residential, Student Accommodation and Commercial sectors in both the UK and Ireland.
We’re regulated by the FCA (Financial Conduct Authority) and broker finance for a wide range of legal entities to include Limited Companies, Partnerships, Limited Liability Partnerships, Sole Traders, Trusts, and Offshore Vehicles.
With over 35 years industry experience in sourcing Development Finance we have the knowledge, skills and contacts to secure the finance most suited to your needs, be it amount, pricing, ease of underwriting or turnaround time.
If you wish to discuss the content of this article, a specific project or the market in general please do get in touch.
Gary Walsh | Optima Property Funding Ltd