The Brexit factor

Ben Lloyd of Pure Commercial Finance gives his views on how Brexit is impacting property developers.

The ever-present debate over Brexit has continued to plague public and market sentiment, and it was particularly heated in the last 24 months with the growing uncertainty around how and when we leave the EU and the current political situation.

The level of impact leaving the EU will have on the UK property market has been heavily speculated on. From the fear of rises in the cost of labour and construction that could cause viability issues, right up to completed property prices dropping.

In September 2018, the Bank of England (BoE) stated that we could expect to see a drop as low as 35 per cent in a no deal situation. I almost feel that the BoE reporting on such statistics is economic self-harm, as the reality is that the sensitivity of our housing market is based on consumer confidence, and reporting on hypothetical statistics in such a way is a sure-fire way of creating poor consumer confidence, panic, and a negative buy and sell environment.

From the front lines, hearing statistics like this and waiting for greater political clarity are a direct cause of uncertainty for some clients when it comes to making decisions on proceeding or not with a purchase, sale or project.

That being said, the sector is still seeing a consistent level of clients proceeding across investment property, land acquisition, property development and consumer house purchases, and continued reporting that house prices are either growing or remaining steady in large parts of the UK is positively counterbalancing consumer confidence. If we can maintain a reasonable level of consumer confidence, then you will see house prices and deal flow remain fairly steady across the UK.

That being said, the sector is still seeing a consistent level of clients proceeding across investment property, land acquisition, property development and consumer house purchases, and continued reporting that house prices are either growing or remaining steady in large parts of the UK is positively counterbalancing consumer confidence. If we can maintain a reasonable level of consumer confidence, then you will see house prices and deal flow remain fairly steady across the UK.

The countrywide fall of house prices will likely be less severe than the BoE has predicted. Regardless of the outcome of Brexit, the UK remains a highly soughtafter property destination and a general housing shortage should appropriately mitigate any sharp or significant drop in prices. The continued uncertainty both pre- and post-exit will however continue to affect market confidence and probably prices, just not to the extent of the BoE’s predictions.

As for the point of view of funders, anecdotal evidence shows that the majority share this same or similar view. Many believe that prices will generally remain consistent, with some moderate dips expected in particular locations or asset classes, but lending decisions and risk mitigations are of course being factored into most deals when they are being underwritten.

It’s safe to say that most lending decisions have had the “Brexit factor” taken into account when looking at value, loan to value exposure, asset class or marketability of the assets being proposed for funding. This is to protect both the client and lender.

As a result of this, and with some client uncertainty, a few less deals are being done at the moment. However, with that, it is important to note that more considered deals are being done – which is to the benefit of both the lender, borrower and market sentiment in the long-run.

Working better with lenders

Developers’ profit margins and viability are coming under greater scrutiny in lenders’ due diligence. Two main reasons for this are the risk of values dropping by the time the units come on sale, and the risk of any increase in construction and labour costs.

If end values are at risk of decreasing or the build cost rising or worse, both together, the viability or motivation and focus of the developer to see the project through could become a serious concern to a funder, particularly if these factors mean there is now no profit left in the project for the developer.

It is absolutely essential in today’s market that both the developer and lender heavily stress test the financials of a proposed project to ensure the project is viable and profitable in the event adverse factors occur.

Some simple ways of doing this are as follows:

  • Commission an independent build cost report from cost consultants and take into account how these would look against a range of adverse market projections.
  • Commission a ‘redbook’ valuation on the residual price that is being/has been paid for the site/building and what the projected end value(s) of the completed development will be.
  • Obtain a few local agents’ opinions on the end value and demand, so local knowledge has been factored in not just via the redbook.
  • Stress test the financial appraisals to allow for a flexing of both a decrease in value and rise in costs, individually or together, to assess viability in adverse conditions.

Ben Lloyd is managing director at Pure Commercial Finance