Smart decision-making is essential in property development. But what are some common mistakes that even the most experienced property developers can...
How has 2022 started for property developers?
2022 has proven a mixed bag for property developers so far. The year started full of promise, but inflation and the war in Ukraine has undoubtedly made all stakeholders in the industry proceed with more caution.
For many, rises in GDV have offset the meteoric rise in building costs and allowed them to progress with sites regardless. Having said that, with further cost rises to come and potentially a weakening economy that will inevitably result in plateauing GDVs. Something will have to give.
To further add to the rising costs developers have to bear, interest rate rises are pushing up the cost of debt. We’ve written about the effects of rising borrowing costs here.
Historically, land prices would have given way already by now, but there is so much competition for land, supported by a great deal of liquidity, that so far price reductions haven’t happened at scale.
This however, doesn’t mean it won’t. In fact, I think it has to. And we’re already starting to see early signs on a daily basis when talking to developers. Overages and deferred land payments are definitely becoming more commonplace.
A big part of any price correction is down to the agents selling the sites. We’re often asked to run appraisals for borrowers on projects and find that the sites simply don’t work because the land price is incorrect.
If your GDV is accurate and your build costs are accurate, and the scheme doesn’t deliver the profit you need (most developers are working to 20% profit margin post-finance), then the land price is wrong.
This is a great example of how to work out a fair price for your land.
Ultimately, the GDV and build costs are only going to vary by a small percentage either way, so the land price is the variable that needs to change if the project numbers do not work.
What does the rest of 2022 hold?
Uncertainty, created by war and the huge inflation figures we’ve all been warned about, will almost certainly see some of the heat evaporate from the UK residential property market.
Are we going to see a market collapse? I don’t think so. But as a developer you can no longer rely on increasing prices to bail you out if you’ve underestimated your project costs.
I believe property prices will plateau, but if material and labour costs continue to rise, then land prices need to fall for the numbers to continue to work. This is great news for developers, but it will take time to fully come to fruition.
As we said earlier in the piece, if the GDV is correct and the build costs are accurate, yet you’re making less than 18%-20% profit after finance, the land cost is wrong.
Good agents will understand this, and the majority will have run through a similar appraisal exercise themselves to arrive at the sales price. They will know all too well that increasing material and labour costs, and plateauing end values, mean that land prices are under pressure.
So, is it a good time to buy?
It’s always a good time to buy, if you buy at the right price. As everyone in the industry knows, your profit is made from the price you pay for the land.
We are however still seeing and hearing about bidding wars for sites, so it’s certainly harder to find value. It’s therefore more important than ever to use your network in these markets to seek out the uncut gems in need of a polish.
We’ve got plenty of examples where planning delays have turned sites from extremely profitable, to barely viable.
I was looking at appraisal costs recently, with a midlands-based developer on a site that has been delayed by the local authority. We compared the project figures for the site from July last year, to now.
The GDV had increased by a very healthy 4.9% in nine months, but build costs had gone up by a whopping 18%. It’s these eventualities that are difficult to plan for and are all part and parcel of the risks developers juggle every day.
Looking beyond 2022
Property development is counter-cyclical to pretty much all other property sectors.
If you’re buying land with planning today, you’re not going to deliver those units to market for at least two years.
If you’re buying without planning or with outline planning, then it could easily be three years.
Whilst the next 12-18 months might be tricky, beyond this there’s no reason why the market shouldn’t be thriving again.
In summary, unlike a finished units buyer, or someone looking to do a quick 6-month ‘tart & turn’ on a dilapidated auction property, as a SME property developer, the market is on your side.
Land prices should come down this year and next, but by the time you deliver the project, end unit prices should be on the up once again.
The lending environment
The UK development finance market is currently very much a buyer’s market.
There’s a lot of competition for property development loans, but I’m pleased to say that for the most part, we’re not seeing lenders take undue risk. Lending decisions still seem to be prudent and cautious, and if anything, due to cost uncertainty caused by forecasted inflationary pressure, lenders are being more rigorous when stress testing deals.
How do lenders stress test deals?
The obvious one is to increase build costs by 5% / 10% / 15%, and then drop the GDV by the same percentage intervals.
A lender will ask, when does the project stop being viable and how likely are those scenarios based on location and other variables? The most common thing we see at the moment is adding 10% as a standard build cost contingency but we’ve seen some lenders ask for 15% to 20% contingency for some listed building or barn conversions.
Personal guarantees, or rather the ability to access liquidity to cover build cost overruns, are vitally important. Can you raise money against background assets without having to sell in the event you need ready cash?
Can the borrower repay the loan by refinancing the properties at the end, rather than sales?
How strong is the main contractor?
These are all questions that need to be asked.
Almost 1 in 5 of all UK insolvencies in 2021 were in the construction industry, so this is the biggest concern for lenders at the moment (and rightly so).
Lenders will look at the contractor’s accounts at Companies House, so make sure you do that first. You don’t ever want to be in a position where a lender finds out something you didn’t already know.
You can also run your own checks. Ask them directly – do they have enough cash flow? How many projects are they running? Have they got lots of borrowing? Are they in arrears? Ask for bank statements or management accounts if you need to. A contractor with nothing to hide shouldn’t have a problem with this.
These things and more, are all of the points a lender will consider when deciding to lend on your site, so make sure you’ve addressed them first.
How do I ensure lenders want to fund my project?
Lenders tell us that the number one reason they pass on projects, or rather, don’t invest the time to understand a project, is poor presentation.
You could have the best project in the world, but if you haven’t invested the time to show you have thought about the same risks as the lender, then securing the right funding will be an uphill battle.
In a recent webinar we showed developers how lenders think when it comes to project presentation, and how to put together the perfect presentation in the eyes of a lender.
We’ve also created a free guide that explains the key points.
Fortunately, Brickflow’s software generates award-worthy presentations for free in minutes. We’ve done the hard work for you, so you don’t have to.
Simply follow the on-screen instructions to create and send an impressive presentation with all the information a lender needs to make a quick and reliable underwriting decision. Here’s an example.
This feature is being tested in beta at the moment but will be live in the next few weeks. To be notified of this software update, register on Brickflow by completing a loan search and entering your email address.
For more information on property development finance, or to discuss your next loan requirement with one of our development finance experts, please call us on 020 4525 6764 or email us on firstname.lastname@example.org.