DAVID NORMAN OF DAVON GIVES HIS ROUND UP FOR SME DEVELOPERS IN 2022 AND HOW TO FORGE AHEAD IN 2023
When we did our ‘state of the market’ round up early in 2022, inviting colleagues across the industry to comment, little did we realise just how much the global and economic markets would change. Commentary, just 12 months ago, was focusing on green issues, the impact of a post covid world and excitement that the planning system might be overhauled. Fast forward almost 12 months later and inflation, interest rates and the war in Ukraine and resultant impact on energy prices are the hot topics now affecting SME residential developers. Not to mention the demise of the much-lauded planning white paper.
The key worry for developers now is the impact that rising interest rates will have on the affordability reality of buyers to borrow and of course developers’ own borrowing capacity. In November 2022, Savills reported that ‘Although the overall number of new build sales are set to fall in 2023, overall market activity is expected to rise from 2024, and if the 1 in 10 ratio of new build to second hand transactions holds, we would expect new build market sales to return to 110,000 per year by 2025.’
The current consensus seems to be that markets will stabilise in 2024, and with it interest rates. In addition, sellers who would have held off moving, will be eager to get going once the climate allows. However, developer’s borrowing capacity looking ahead to 2023 may be impacted. The market situation has already caused some senior debt lenders to reduce the level of gearing they are comfortable with, and this, combined with the likelihood of slower sales will increase the pressure on developer's own capital. In reality, this is likely to increase the demand and highlight the benefits of utilising mezzanine finance within the capital stack of a scheme; by doing so, developers should be able to continue funding schemes to a level that works for them. As always, in more challenging market conditions, the fundamental strengths and qualities of any project will be even more critical to ensure its success for the developer and all those involved.
Buyers are still keen on green. This has come to the fore even more with the cost-of-living crisis affecting almost everyone. SME developers can ensure that new builds have excellent insulation, efficient heating systems and triple glazing for example. All these elements would mean reduced costs in bills for those buyers looking to move in the next 12 to 18 months and these green inclusions are relatively inexpensive when building from scratch. Further incentive for SMEs to build green was highlighted in one of my articles earlier this year, where several banks are offering preferential rates of finance to developers who are prepared to build significantly green.
The cost of construction materials and possible labour inflation continues to rise with the Department for Business, Energy and Industrial Strategy (BEIS) reporting that cost of materials rose by almost a third in May, compared to the previous year. Some of these monetary challenges can be offset by using smart technology in the form of Proptech, as discussed in previous articles I have penned this year. The use of Proptech and employing software such as Aprao (aprao.com) to streamline the entire construction cycle means that small developers can plan, monitor and execute developments efficiently and react quickly to change. Daniel Norman of Aprao, a leading UK proptech provider, says the industry is at an inflection point in real estate, where the next generation of change makers are taking over key positions within leadership and innovation across the sector. Those in real estate are now looking for more data, greater transparency plus efficient processes and software to build strong and resilient businesses which will stand the test of time.
In conclusion, my outlook hasn’t changed from earlier in the year. It remains difficult to predict how deeply the continuing hike in interest rates will affect the UK economic landscape long term. The uncertainty means SME developers will inevitably approach future schemes with more caution, in terms of pricing and size of developments, although past experience has shown that SME developers are a resilient breed. Because of their size, they can execute decisions quickly and react swiftly to the needs of their local markets, which means pricing units to sell, while providing homes that satisfy local requirements; which, if done with meticulous attention to detail and tenacity, new build homes will remain in demand, despite trying economic conditions.