The Outlook For Development Finance

Posted by Mesa Financial on 27th July 2022 -

Developers are currently experiencing the prefect storm of high asking prices for land, increased construction costs, material shortages and rising interest rates due to lockdowns in China and the war in Ukraine. To what were originally profitable schemes when first appraised are now transitioning to reduced margins for developers meaning schemes may become unviable, unless land prices can be renegotiated.

Main contractors that have agreed fixed price contracts are also having to address initial agreements midway through projects which naturally cause delays with construction. The main benefit of advising is exposure to multiple funders that have access to a wide range of data and information. The general consensus from lenders in the current climate is caution around contractors running into financial difficulties with one lender in particular noting that "more and more CCJ's are coming to light which is causing concern". Insolvencies in the construction sector have also been rising (up 85% in the 12 months to March 2022 according to BEIS) showing signs that some businesses, mainly contractors, are struggling with rising costs.

Lenders are requiring build facilities to include increased contingencies. However, it's not surprising these are being utilised in a fairly quick timeframe with the ongoing material and labour costs (material costs for new housing have risen by 23% in the 12 months to May according to BEIS). If lenders won't fund cost overruns, developers certainly need to have access to more cash in order to fund the difference and keep construction moving.

1. Contingency. 10% as a minimum. Avoid any unwarranted surprises when the monitoring surveyors report is produced.
2. Professional team. A solid professional team will pay dividends in the long run, especially contractors with healthy balance sheets.
3. JV/Equity Partners. If cashflow is tight then equity financing may well be a solution.
4. Funders. There are really high number of development finance providers that need to deploy capital and will support SME developers throughout this inflationary period. Partnering with the right lender is key and decisions shouldn't just be directed by headline rates.

Quite a number of lenders have had to increase margins due to inflationary pressures, reduce loan to cost and loan to values across projects which is requiring developers to inject more equity. We predicted that more equity financing would be required and the enquires have certainly proved that over the past 18 months on a multitude of projects. SME developers tend to have less control over supply chains unlike major housebuilders, not as cash-rich and the development cycle tends to be much shorter as not all developers have the luxury of sitting on projects in order to wait and see what happens.

It's paramount lenders apply a level of flexibility with developers (some funders will forward funded material costs) and advisors really support borrowers on current projects, whether that be refinancing projects or restructuring. While the market has an element of uncertainty, it will at some point stabilise allowing SME developers to rebuild their pipeline of projects and become more aggressive. Ultimately, homes still need to be built and home ownership and investment is still very much an aspiration in the U.K. attracting a global audience.