Finding finance

With the well-documented need for the UK to increase its housebuilding activity to satisfy demand, Andy Keal of Midlands Asset Finance explores the increasingly attractive finance options available.

Evidenced through changes in the planning process and political support for increasing the rate of housebuilding, the financial outlook for housebuilders is positive.

However, for the regional and smaller housebuilders to be successful, they also require access to development funding, for both the site acquisition and development stages, ideally with increased leverage to allow them to optimise the use of existing capital and increase activity.

The traditional high street banks face the challenges of balance sheet ring-fencing and increasing capital adequacy ratios. Developers have subsequently turned to leverage providers through specialist brokers who can access a whole range of funders in the sector.

These providers – ‘challenger banks’ and private equity-backed funds – have filled the void, with provision of development finance facilities at typically higher Loan to Cost (LTC) and Loan to Gross Development Value (LTGDV) ratios.

Facilities that are offered generally require the developer to introduce 25 per cent of the total development costs (of land, construction, professional and finance), with the funder extending a facility for the remaining 75 per cent, that usually translates into 60 per cent LTGDV on a fully-funded basis depending on the profitability of the specific scheme.

The challenger, with their lower capital adequacy requirements, achieve their individual return on equity thresholds by pricing the debt 1-1.5 per cent beyond the traditional bank’s cost of funding, while maintaining sensible credit risk criteria.

They will also generally require a shareholder guarantee, whether from an individual or associated company of worth (usually limited to 20 per cent of the loan facility) to ensure that focus is maintained by management in the case of unexpected events, such as cost-overrun or delayed cashflow, and their credit decisions are provided quickly, with credit officials often meeting the client and visiting the site.

The sector remains attractive with December 2017 reports from Nationwide and Hometrack predicting that, while London house prices may remain relatively soft in 2018, they will be offset by the anticipation of growth in the regions, specifically cities like Manchester, Birmingham, Leeds and Glasgow.

These growth expectations are supported by prices coming from a lower base, a general absence of foreign buyers and more manageable mortgage multiples. Consequently, the challenger banks and private equity funds appear to be less London and south east-centric, as they look to sustain and increase their loan books that (defined by their short-term nature) ‘churn’ quickly.

2018 will witness them increase their reach into the regions, to supplement their existing current regional interests in predominantly bespoke student facilities. This outlook, together with the returns when compared with other less “secure” investment opportunities in the UK, has seen an increase in the number of new property funders entering the housebuilding arena.

With the increased competition, the industry is beginning to see, rather unsurprisingly, more competitive development funding packages emerge, with lenders considering 85-90 per cent LTC and 65-70 per cent LTGDV on a fully funded basis for an attractive scheme.

The increased leverage naturally attracts slight premium pricing and each individual developer will have their own view, but with the re-emergence of pricing for risk, the developer at least has choice.

In instances where the developer has acquired the land and “worked–up” planning to deliver planning gain and value enhancement, the challenger banks will acknowledge the efforts of the management team and ascribe added value when assessing the development appraisal.

This can result in a funding offer that is equivalent to the total development costs (construction, professional fees, finance and marketing) without the requirement for further equity injection, assuming the land is held unencumbered, allowing developers to be able to achieve 100 per cent development funding.

Andy Keal is senior relationship manager at Midlands Asset Finance