Why finance UK residential developments?

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Recent market fundamentals have placed UK residential developments under the spotlight, in the eyes of property lenders. This article will discuss the reasons why the current environment makes residential property an exciting funding opportunity.

Supply

New-build residential supply has picked up with 217,000 homes coming on to the market in 2016-17, rising by 20% on the year before and 62% over the last five years. This only brings the total back to pre-financial crash levels, in turn, supply needs to rise by an additional 28% to reach the government target of 300,000 net additions a year. Whilst new delivery has been boosted in recent years by permitted development rights, there is still a shortage of new homes in areas where they are most needed. The government’s focus on the Oxford-Milton Keynes-Cambridge corridor suggests that up to one million homes will need to be built along the stretch by 2050. Turning to the London market, we observe an increase in the net supply of new-builds to 39,560 in 2016-17, compared to the 66,000 new homes needed in the capital per year.

Lack of lending

According to the Knight Frank residential property outlook, the current cost of private-sector funding for developers signifies a shortage of available debt capital, especially for smaller SMEs. Despite the Chancellor’s efforts to boost funding for the Home Building Fund, debt finance for residential developments is scarce, particularly in the regional markets. With high street financiers turning away from the development finance market after the crisis and with UK clearing banks ruling out financing options for speculative schemes, developers are starting to turn to innovative debt financing providers for solutions.

Attractive margins

Whilst lenders are currently competing in the senior space market, squeezing margins to as low as 1.5%, the scarcity of loans for the residential sector allows lenders to enjoy high margins ranging from 5-9%. With developers like Barratt planning to continue building 25% of its homes on land sourced from its strategic pipeline, acquiring strategic land continues to be a key strategy, which allows to retain greater control over land pipelines and maintain margins. With this in mind, lenders must be prepared to face construction risks.

The blossoming build-to-rent market

The 22% year-on-year increase in build-to-rent investment, has bought investment levels in this market to £2.4 billion in 2017, leading to a 45% year-on-year increase in the total completed and a 47% increase in the number under construction. US and Canadian long-term institutional investors, such as pension funds, have greatly contributed to these figures, given the attractive stream of rental income generated by such schemes and given their acquaintance with the similar multi-family model in their domestic markets. Local authorities, councils and housing associations are also looking to partner with build-to-rent developers, both for gaining long-term returns and for achieving their housing targets.

The possibility of redeveloping

With the retail sector losing its attractiveness, many retail parks are now viewed as an opportunity for redevelopment into residential spaces. This strategy extends to all underperforming real estate assets and is now more valued by local authorities, given the Chancellor’s housing aims laid out in the last Autumn Statement. Development finance lenders are increasingly looking into such schemes, given their ability to gain long-term investment returns, while mitigating the risks associated with stagnating or shrinking rental income.