Chris Hector of Davon discusses the challenges facing residential developers in 2024 and how to get beyond them.

The Market

Glancing at the ONS data on house prices, it would be easy to conclude that the supply and demand imbalance continues to keep the market steady.

After all, according to government statistics, the average house price in England in August was £310,000, the same as a year before.

But anyone who follows the housing market knows it is far from steady. The month before, Nationwide reported that house prices had fallen 5.9 per cent in the same period.

And the ONS data shows prices slumped nine per cent year on year in March before rebounding by August. Just two years ago, annual increases between 10 and 15% were being recorded.

Uncertainty is reflected in the ping-pong nature of the house price data

A series of political and economic shocks from Brexit through Covid and war in Ukraine have unsettled business and consumer confidence, which falls and rebounds through each successive setback but leaves a lasting feeling of uncertainty. Naturally, that is reflected in the ping pong nature of the house price data.

In our experience, uncertainty or even full-blown recession doesn’t make it impossible to make a success of small or medium sized developments but it’s crucial to get the fundamentals right from strategic decisions about land acquisition, location and type of property to sourcing materials, finance and labour.

We are pleased to see clients making a success of developments despite the challenges.

Challenges

SME developers operate in a UK housing market for new homes where the goalposts rarely remain in the same place for long.

But many other factors come into play that make basing a small business on building new homes a tricky proposition.

According to the Federation of Master Builders, 40 years ago SME house builders delivered 40% of our homes. Today, this figure is just 12%.

The FMB says the sector has been hit hard by successive recessions. SME and custom builders say they struggle to access finance and land, and to navigate Britain’s complex planning system.

At Davon, we have given our support to the FMB’s campaign for:

• A simplified planning system
• Making more small sites available for SME developers
• Investing in local authority planning departments to speed up the planning process

When it comes to getting projects up and running, I could sum up the situation in one short phrase: Everything takes longer.

Successful developers build in an allowance for delays

It takes longer to find and acquire land, it takes longer to get planning permission, it takes longer to get bank funding and it takes longer to get materials delivered. Successful developers know they must build in an allowance for those delays, which inevitably increase costs, on top of higher inflation and borrowing rates.

The Department for Business and Trade reported a 4.5 per cent increase in materials costs for new housing in July but some materials eclipsed that with insulating materials notching a 29 per cent rise, ready-mixed concrete up 19 per cent and screws a third more costly than last year.

Cashflow is an issue for SME developers. That’s true for most small firms but especially so with a speculate to accumulate business model. It means small developers must lay out large sums of cash up front and throughout the construction life of each development, if not beyond. What’s more, those funds are typically tied up for many months and often years.

Unfortunately, banks dislike lending against developments pending planning applications

Even a small development of, say, two houses can incur upfront costs of £30-50,000 in planning and professional fees. For more complex projects, that number can easily top £100,000 when you factor in consultancy fees for a broader raft of planning hurdles such as right to light and environmental studies. Another big-ticket pre-planning bill can be option fees for the landowner.

Unfortunately for developers, banks dislike lending against developments pending planning applications as there are no assets in the project, which means the developer has to find the cash.

And the cashflow strain doesn’t necessarily go away once a developer gets through the planning process and has agreed a bank loan.

With many suppliers now demanding upfront payments, small developers increasingly find themselves dipping into their pockets to secure deliveries. Once again, it happens because banks typically dislike releasing funds that aren’t secured against tangible assets, in this case materials that are yet to arrive on site.

All this means that SME developers are often locked into their current project, unable to move onto their next because of lack of cash until the development completes and sells.

Opportunities

But what if there was a way to release cash for that next venture?

This is where mezzanine finance comes in. We have seen a big increase in demand in the last year or so as developers grapple with the cashflow challenges being heaped upon them.

By providing a tranche of second-tier finance behind the bank loan, mezzanine lenders such as Davon free up part of the developer’s equity that was previously locked into the current project. This can then be used to cover the upfront costs on the next development or to offset rising materials prices on the current one.

The future

So what lies ahead?

In its way, mezzanine finance might be described as a disruptive technology, changing the traditional way of funding developments and making strategies possible for smaller businesses that were once the preserve of deep-pocketed behemoths.

Mezzanine finance is changing the traditional way of funding developments

And it is not just in our own business that we see more SME developers open to new ideas such as using technology, if not directly then through the professional team they hire for projects, who are more and more likely to employ BIM and modular construction techniques, for example.

In our experience, Artificial Intelligence has yet to make a serious impact on the world of SME development but given the exciting pace of change anticipated in many related areas, such as property law, it is surely not far away.

Whatever lies ahead in 2024, our clients have a strong record of making projects work, and despite the real pressures on the industry, that gives us confidence.