Developing in uncertain times

Developing in uncertain times.

No-one within our industry will have failed to notice that the economic outlook has changed significantly since late September. For some, this may be the catalyst to take a break from development and to wait and see what happens. For those of the more “glass half full” disposition, this new economic landscape could provide new opportunity.

Whilst I agree that success can still be achieved in a challenging environment, it is important to think carefully about how to best navigate these fairly unchartered waters.

Interest rates have risen considerably over the last six months and this trend is likely to continue to both preserve the value of our currency and to attend to inflation. You should therefore budget for increased funding costs with any development and ensure there is sufficient margin to cater for further increases during your build. At time of writing, fixed rates have all but disappeared and therefore you need an understanding of what rates may do until you are in a position to repay your development funding. Be alert to bank covenants which allow for revaluation during the loan term as, in my experience during the last recession, the lenders surveyors rarely have a positive outlook! A breach in your loan to value covenant could result in your lender requesting a margin call payment from you to rectify an alleged breach.

Contractors have experienced issues since the start of the Covid pandemic both in terms of procuring materials and ever increasing material costs. These issues are set to continue and it has become more commonplace that, even in fixed sum Builders contracts, there is a provision to alter the price to accommodate changes to material costs and to delay the completion date due to difficulties in procuring materials. Cost implications will directly affect your scheme profit and delays will likely increase the funding costs you will incur.

It also remains the case that Contractors are generally very busy. You should try and arrange any funding so that it can be drawn down once the Contractors are on site rather than in advance of works starting. Holding borrowed cash funds, when not necessary, will lead to wasted interest costs and the eroding effects of inflation, both of which could impact your project profit.

In furtherance of this, you should ensure that all your compliance matters are in place so as to minimise any delay for your project. Predictive SAPs, party wall matters, discharging planning conditions and the like should all be undertaken before you draw down your development funds.

You should also ensure that your build cost calculations are based on the current building regulations rather than based on a project you have perhaps previously undertaken. Increases in material costs and the recent changes to the thermal requirements within the Building regulations will mean that any historic costings will likely be inaccurate. You may also wish to adapt how you pay Contractors given that the current economic outlook means that the number of contractor insolvencies is likely to increase. You need to protect your funds to ensure that you do not have a builder go out of business on your project and that you are left with insufficient funds to get an alternative firm to complete the works.

A further consideration is that higher interest rates, persistant inflation and an uncertain economic outlook could mean a reduction in house prices. The market largely works on the basis of consumer confidence and when that is dented, the demand is often removed from the market leading to falls in prices. If you are planning on selling your completed development you should consider the likely price movements during the build programme and this too should be factored in. It would be incredibly helpful if you could secure some sales off plan as in uncertain times, a bird in the hand will rarely be a bad idea.

If you are developing to hold and rent then whilst the cost considerations for development are still relevant, the ultimate rental figure achievable is likely to remain applicable. A restricted supply of accommodation is likely to prop up prices over the medium term. That said, if you are planning on moving your development funding onto a term loan Buy to Let mortgage, then you should be prepared for higher rates either on a variable or tracker rate rather than assuming a competitive fixed rate will be available.

Personally, regardless of your development strategy, I would suggest that you focus on smaller schemes with quicker turn round times. Longer development times will increase risk as they are more likely to overrun in terms of cost, time and potentially more likely to test the patience of your funders.