Written by Tom Berry
This time last year, the development finance market was a very different landscape than it is today. Almost 2 months into the UK’s first lock down, lending across all asset classes was hugely restricted. Fast forward to the present day and we have seen a huge influx of liquidity into the residential development finance sector in the last 6 months, as the economy continues to recover. There are a variety of factors which have led to this, helping to contribute to an increased availability of development finance.
The first, is the ongoing support the housing market receives as the main driver of the UK economy. The current conservative government has a manifesto pledge to increase supply of housing by committing to 300,000 new homes per year in the UK, with a focus on rebalancing the housing market towards home ownership. These targets have not been met in the past, so the government continually needs to find ways to stimulate the housing market and enable development across all tenures. There are several initiatives that have been introduced and improved, in order to increase UK housing stock, which in turn increases the rise in development funding we are presently noticing.
Homes England are the department responsible for facilitating residential development in order to reach the government’s target. Utilising the government’s funds, they provide senior development loans to private developers where the mainstream lenders might not. They also assist first time developers without the track record required to secure funding when more cautious lender are less permitting. More recently, they have expanded their offering by partnering with challenger banks like United Trust Bank. This allows them to provide junior debt, against the banks senior debt creating low cost of funding on an overall higher geared capital stack.
The most recent example of how the government is trying to stimulate the market is the introduction of a 95% mortgage guarantee. It is available to all types of borrower, not just first-time buyers on all properties up to £600,000. Although on the surface this may not help a wide range of borrowers as it does not increase mortgage affordability, it will allow those with a low deposit access to home ownership, and in turn, the current owners of those properties to move further up the ladder.
The availability of efficient mortage poducts has made it easier for people to buy, whether they are first time buyers or not. Facilitating this boosts the whole development cycle by supporting sales, improving perceived risk within the lending market and in turn, access to development financing.
These aren’t however the only factors affecting the noticeable changes in the past few months. One of the most obvious explanations for the recent influx of liquidity into the market is the effect the pandemic has had on the commercial sector. For over a year now, many businesses have remained closed, with offices left empty as people continue to work from home and our high streets struggling to compete with the dramatic uptake in ecommerce. In addition to the government’s initiatives helping to simulate the housing market, lenders and investors have reacted to the change in the commercial markets over the past year. Certainly for now at least, commercial investment has been deemed too risky and volatile for most lenders. As a result, lenders are opting to place their focus on more stable lending propositions and for now, that means allocating their funds into residential development products. Considering that the typical term of a residential development loan is around 18-24 months, lenders are able to mitigate the current risk associated with the commercial market until the effects felt by the pandemic stabilise. The residential development products avabliable are not only liquid but comptetive. We have noticed a rise in LTGDV and reductions in overall cost of funding, as lenders seek to utilise their capital in a more reliable space, the residential development market.
Optimistic developers may find they have more profitable schemes due to the cost efficient products available, resulting in a higher ROE for the borrower. In the first instance, the borrower will feel more secure and confident with their anticipated profit levels. Suggesting that prospecting borrowers will consider more schemes that they could do in the average year. With more liquid equity available, developers will be able to explore more opportunities than they would typically, perhaps schemes with more units, higher GDVs, enabling their overall growth.
The residential development finance market is a complex balance of different influences, and how long abundant liquidity will remain will depend on how well the economy bouces back as it gradually starts to reopen. In the short term, there is a huge incentive for developers to take on new projects, take advantage of the finance available and the uplift to their anticipated profit levels. The combination of the continuous support the housing market receives from the government and current risk associated with investment within the commercial sector has resulted in increasingly competitive finance, boosting both the developers margins and the ease at which it can be acquired. In the long term, this will have a positive effect on the finance market for both developers and lenders as those projects complete, and the capital can be recycled encouraging the growth of both the developer and lender.