"It might come across as overly pessimistic, but given the housing shortage and the Government’s own targets for new build homes over the next 10 years, I’m struggling to see how developers will be making their numbers work without the dynamics significantly changing"
The popular perception of a property developer is of someone making easy money and profits from building homes, but even when times weren’t as hard as they are today, the reality has always been considerably more nuanced.
Property development has forever been a balance between risk and reward but following Brexit, Covid-19 and the invasion of Ukraine, it’s become a whole lot harder to make the numbers work. Costs are continuing to rise and developers are having to adjust to a new reality where cash flow needs to be managed ruthlessly and profit expectations have to be lowered.
To illustrate the extent of the challenges that developers currently face, here is a project viability exercise of a real development which completed in 2018 compared to how the same development would look today:
| Project Viability Summary | ||
|
Five apartments built on a plot replacing a 1920’s bungalow |
||
| 2017 | 2023 | |
| Site purchase price | £1,200,000 | £1,200,000 |
| CIL payment and planning/professionals’ costs | £60,000 | £75,000 |
| Stamp Duty | £97,500 | £97,000 |
| Build cost plan | £1,000,000 | £1,300,000 |
| Agent’s legals and sales costs | £40,000 | £40,000 |
| Funding costs (£1.5m) at 6% over base over 24 months | £195,000 | £315,000 |
| Total costs | £2,592,000 | £3,027,000 |
| Total sales prices x 5 units | £3,200,000 | £3,040,000 |
| Gross profit | £608,000 | £13,000 |
You don’t need to be an accountant to understand just how tough things have become over the last six years.
The cost challenges
Developers face a significant rise in costs before a shovel has even broken ground. It’s easy to overlook the fact that, from the outset, a developer will be paying Stamp Duty on the value of the site or the purchase price of the property being developed – even if the development is delayed or doesn’t happen.
There are other costs which wouldn’t be obvious to an inexperienced developer. When planning consent is given by the Local Authority’s planning office it will come with a Community Infrastructure Levy or a Section 106 payment obligation, which is typically payable before the project is complete and again is an irrecoverable cost.
On the subject of Local Authority planning departments, their staff are often overworked and under-resourced, at times adding considerable delay to proceeding, meaning it will take months or even years to approve a development scheme; all the while, inflation is working its ‘magic’ on labour and material budgets.
Since Brexit, it has become harder for developers to secure the skilled labour they require for some of the necessary trades. If that wasn’t enough, utility companies have also struggled to meet their own service standards in connecting water, gas and electricity to new-build sites, often adding further significant delays to proceedings.
Developers’ cost plans and timetables can be extremely optimistic when it comes to building material costs and supply timings. It isn’t unusual for some of the basic building materials such as plasterboard or bricks to be in short supply or, when available, 50% more expensive than they were before the pandemic.
Funding costs have of course also risen. Most developers use debt funding to support their projects in order to provide a meaningful return on their capital. Base rate rises from 0.5% to 5% over the past year have caused a major increase in the cost of project funding, directly hitting the developer’s bottom line. With the anticipation of more rises to come.
Equally, the effect on affordability from inflation and rising rates may well mean borrowers simply can’t afford a property they might have done just a year ago, reducing demand for the developer’s finished product.
There’s no replacement for Help to Buy and there have been no signs from the Government of any other meaningful assistance for first-time buyers.
With all this in mind, it’s easy to understand how a developer might struggle to see the viability of their next project or justify the investment and/or risk involved. It might come across as overly pessimistic but given the housing shortage and the Government’s own targets for new build homes over the next 10 years,
I’m struggling to see how developers will be making their numbers work without the dynamics significantly changing.
If I consider that most of the developers Tuscan Capital has supported over the years work off a 20% profit viability target, then with the increased costs and challenges involved in any building project now, coupled with the affordability challenges prospective buyers requiring a mortgage will face in the short to medium term, I can’t see how such a margin is achievable without Government intervention.
Without such help, I fear developers will struggle to find viable projects and the construction of residential homes will continue to slow.
That clearly has an impact across so many industries – particularly construction – and the economy as a whole given its reliance on the housing market for so much of its growth.
It is clearly not the greatest picture to view at present. However, the positive is that, for those who can make the numbers work, there are lenders like Tuscan who will provide all the support they need - and then some - to make it happen.
