With the pandemic causing the closure and slowdown of many development sites during the past year, alongside numerous lenders pulling out of the market or putting their funding on hold, developers have had a difficult period starting or completing their projects. As we emerge from the dark shadow of Covid restrictions, will Brexit become the next hurdle to hold the development market back?
Phil Gould, principal at Avamore Capital, emphasised that the impact of the UK’s separation from the EU had been felt long before Brexit formally took place. “Soon after the 2016 referendum, the market saw reports around the reduction of available labour from the EU workforce; furthermore, developers were already experiencing the impacts of increased material costs due to fluctuating exchange rates against the euro. Cost overruns and unexpected delays were a clear consequence of Brexit uncertainty before this year (indicated by the launch of our finish and exit product in 2019, which was designed to address exactly these points) and so, we witnessed developers working to the circumstances around them. This year, Brexit consequences may be set to intensify, but developers have had the luxury of time and been able to foresee some of these issues arising, and therefore make appropriate allowances.”
While the housing shortage persists, interest rates remain low, the availability of funding remains high, and the government continues to support the construction sector through planning reform and economic support, it stands to reason why developers are still hopeful.
It’s all about residential
Clearly, there is currently more confidence in the residential sector, which likely reflects the lack of supply, compared with the commercial property market. According to the January 2021 Land Registry UK House Price Index, the average property price stood at £249,309 — a 7.5% rise year-on-year. The North West witnessed the strongest growth, where prices increased by 12%.
“We obviously have an enormous shortage of housing, and it is difficult to see that changing any time soon,” said Adam Tauber, specialist underwriter of development finance at Crystal Specialist Finance. He added that there has been a surge of commercial-to-residential developments and expects this type of conversion to be unaffected by Brexit.
Robert Orr, managing director at Paragon Development Finance, points to the extension of the stamp duty holiday as having provided further stimulus, while the new iteration of the Help to Buy scheme will support those looking to purchase their first home. “Many people have been forced to spend much more time at home and that has helped them reconsider what they want from their property, including quality of finish and efficiency of space, which can be better catered for by new-build homes,” he commented.
“Developers are also marketing property in an environment of constrained supply. Housing stock for sale is below historical levels as people have held off putting their homes up for sale during a pandemic, so this has created a strong environment for developers when combined with an upsurge in buyer demand.”
Roxana Mohammadian-Molina, CSO at Blend Network, commented that government support for first-time buyers has created renewed optimism among developers, “especially those focused on building houses in the more affordable price tranche.”
Access to finance has also improved, with liquidity from credit funds, banks and PE firms flooding back into the development market. In addition, mortgage availability is returning to normal levels and higher LTVs, and the government’s new 95% mortgage guarantee scheme will also assist the buyer market and give developers confidence they have secure exits for their sites. “Being able to access competitive finance has allowed developers to generate good returns on projects, and many are confident investing for the longer term, where returns will be realised in 18-24 months,” reported Cameron Hayes, asset finance adviser of structured finance at Arc & Co.
Prime real estate, especially in central London, is also still seen as an attractive asset for investment and development on a global scale. “Due to the prime market’s resilience, we have seen great optimism from our developer community,” confirmed Uma Rajah, CEO at CapitalRise. Over the past 12 months, the lender’s loan book has benefitted from double-digit growth, having screened over £5.4bn of deals in 2020.
“The pandemic and Brexit did not stop the progression of our projects; in fact, all development sites CapitalRise is currently funding have remained open throughout the various lockdowns and works continue to progress well. The prime property market is strongly linked to international buyers and investors rather than European ones, so the Brexit impact on demand in the sector is expected to be minimal.”
While the huge spike in national debt and rising unemployment could also affect the property market’s confidence and buyer behaviour, Uma believes that the shortage of housing stock and having been in lockdown for much of the past year mean that people are keen to get moving. “For CapitalRise, Brexit is priced into our valuations and has been for a long time. [Provided] developers stay true to the business model that works best for them and they are realistic to the headwinds that lie ahead, then in partnership with a dependable lender, they should still be able to see their projects to completion and, ultimately, profitable success.”
Richard Jones, managing director at Pilot Fish Finance, is seeing a rise in demand for rural homes with outdoor space, which offers developers an opportunity to move into new markets. “Equally, with so many commercial spaces now sitting empty, developers have an opportunity to redesign our high streets,” he said.
The growth in the BTR sector has also given developers access to institutional buyers and new sources of capital, such as forward funding or purchase structures. “This sector will only grow in volume and size as time goes by,” commented Steven Oliver, COO at Peritus Corporate Finance.
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Labour shortages and increased material costs
While the full impact of Brexit is yet unknown, it is likely to be felt through increased prices in raw materials and possible labour shortages, feeding into higher wage and materials costs across the sector. Positively, this could drive down residual land values and the price developers pay for sites — something which is an ongoing problem.
“There’s no doubt that it is becoming harder for developers to complete schemes on time and on budget,” said James Bloom, director at Alternative Bridging Corporation. “A combination of Brexit and the pandemic has increased the costs of materials and created long waits for some items, while sites need to allow for social distancing guidelines."
Planning ahead for both the build and arranging finance is therefore vital. “It’s likely that many developers are going to reach the expiration of their development finance arrangements before they are ready to move on from a scheme, and so it’s important to look into refinancing options early.”
“Our well educated and experienced approach to risk helped us to plan ahead for the likelihood of a hard Brexit,” said Uma. “CapitalRise has always undertaken a rigorous assessment process for new loans. In doing so, we actively challenge what the true costs, programme and demand is for any one project given the location and demographic, together with the validity of comparable evidence.” To date, while it has seen labour shortages and rising costs, the work it undertakes at the outset has held the lender and its borrowers in good shape — “forewarned is forearmed!”
Robert highlighted that the experienced developers Paragon supports have been building in levels of contingency across the board, whether for costs, programme times, or both. “There is also optimism that some of the European labour force who returned to their home countries during lockdown will come back as travel restrictions ease. This doesn’t look to be imminent as the roll-out of vaccines in European countries has been slower, but it will eventually stabilise.”
He also thinks that this is an opportunity for the industry to ask itself how it can appeal to new people and make construction and the property industry an attractive place to work. “Work is already underway to improve diversity in construction and I’d like to see that accelerated,” Robert added.
Phil thinks that there could be an increase in the number of apprentices construction workers take on to fill the skills gap.
As part of the Brexit negotiations, the UK agreed a trade deal with Europe so that the import of building materials from the EU was not subject to additional tariffs. “By signing the UK/EU trade deal, price increases due to increased tariffs has been mitigated,” Steven said.
“With regard to materials, obviously, a lot is sourced from outside the UK, and this results in delivery delays and potential increased costs from the Brexit fallout,” added Eli Korman, head of development finance and chief investment officer at TAB. “However, these are just hurdles — not barriers. Developers and their funders need to keep this in mind and ensure their cost plans are robust and have enough contingency to counteract any impact.”
Steven highlighted that the European lockdown has seen shortages of items such as timber and plasterboard, and factories running at reduced capacities will only extend this supply chain problem.
We might see more developers sticking to traditional building methods and materials. “Despite regional variations across the country, traditional materials sourced locally will be the key to preserve costs and, in some cases, reduce overall costs and increase profit for developers,” stated Adam.
On the other hand, we may see more borrowers expanding their supply chain. Cameron divulges that Arc & Co has witnessed developers sourcing materials from further afield, particularly from some parts of Asia. Developers may also look at ways to agree UK-based supply chains if they have not done so before.
“Clients are looking more intently at their supply chains than ever before and planning procurement far in advance of their needs, to allow time to account for any delays or hold ups while import issues are worked out,” stated Henry South, head of construction insurance at London Belgravia Brokers.
Asim Shirwani, CCO at Lendhub, said that savvy developers will find savings elsewhere, such as through stronger negotiations with contractors on build costs, or cheaper finance packages from lenders.
“From a Brexit standpoint, increased paperwork in relation to imported materials will add further pressure to developers and may also add to delays,” stated Steven. This could lead to more developers using reclaimed materials, which could help save money in the long term, reduce our reliance on EU trade and be better for the environment.
Scott Marshall, founder and managing director of Roma Finance, agrees that developers will adapt and become more efficient in delivering their products. “We are seeing this already; the construction of an individual house is a lot quicker than it was 10 years ago. Off-site manufacturing and modern methods of construction are becoming more commonplace and will only accelerate this.” He pointed out that they also offer huge cost savings, efficiencies and environmental benefits. “I think we will see more of these types of properties.”
What developers should be cautious about this year
There have been reports of a backlog and reduced availability across professional services, such as solicitors, valuers and local authorities, due to high demand and potentially less resource due to the pandemic. This could mean that developers face challenges reaching planning decisions and having valuations undertaken quickly.
Adam believes that developers will be looking at greenfield sites because of brownfield areas being too costly to clear. However, they are likely to face local resistance and planning challenges. “More due diligence and conversations with planning officers will have to be part of a standard development appraisal,” he highlighted. The availability of sites and appropriate infrastructure will also continue to be problematic, with further planning reforms needed.
The biggest hurdle for developers could be around catering for the consumer and the individual needs in a particular area — something which has changed a lot during the health crisis. “Developers needs to think inclusively and not [have a] bottom line, ‘What’s in it for me?’ attitude,” Adam said. This is especially true when looking at the affordability of housing.
Scott references how the profiles of buyers are changing. “There are now more single-person households of all ages, including older people. How do we cater for them? It’s not just about building more homes; we need to be building the right kinds of homes.”
This is also compounded by the requirement for more space at home and the paradigm shift of flexible working. “This will have an impact on consumer demand and the way developers and their professional teams look at designing buildings,” said Cameron. “Squeezing more units into a development may no longer be the best way to maximise return — especially if they take longer to sell.”
Covid has made many people question the desire and need for city centre or urban living. “Developers who have focused for the last decade on urban developments would be well served to diversify their offerings and cater to the growing number of people who are prioritising space over convenience or commuting time,” added Henry.
Graeme Walker, development finance head of lending at Hampshire Trust Bank, advised that potentially higher levels of unemployment following the end of the furlough scheme will have to be managed carefully. “Unemployment will impact some specific geographic locations and demographic groups more than others.”
Eli warned that as sites get finished and come to market towards the end of 2021 to early 2022, there could end up being an oversupply, forcing sales values down. “This could push developers into holding some of the units rather than selling,” he stipulated. “However, when coming to refinance, developers need to be aware that the valuations of GDV that they had been working from prior to Covid are likely to be significantly lower — meaning they may not be able to refinance at the same level they expect.”
Phil remarked that, while the housing sector has been supported throughout the pandemic, it cannot last forever. “In times of prosperity, it is likely to be one of the areas where the government will look to claw back some of the economic losses it has incurred, particularly over the past year. We are already seeing that with the end to the stamp duty reduction on the horizon, and it is likely that there may be a further increase in taxation in the medium- to long-term, and this could have a big effect on willingness to buy and sell. For the moment, however, riding through the Covid storm and making the most of current government support seems to be the main priority for developers.”
It is also important to note that developers are not immune to the return of the stamp duty land tax, which will be brought back in September. “Most experts believe stamp duty to be outdated, as it is levied on purchase rather than profit and is deemed to be one of the main deterrents for people looking to invest in property,” said Asim. Therefore, this could impact the exits of such developments.
Looking at the positives, Robert sees 2021 as more of an opportunity than a challenge. “All being well, the economy should emerge strongly as we rebuild following coronavirus, while some of the trends we have seen emerging over the past decade — such as the growth of online retailing — have been gathering speed. This creates opportunities across all sectors. An area that interests me is the revitalisation of town and city centres and the role property developers could have as we reimagine our towns with mixed living, retail and hospitality spaces. Shifts in how we work also open up new areas for developers outside of traditional commuter lines.”