"It is important to pre-empt those intensified financing factors, which may impact timeframes, costs and ultimately profitability, and plan differently."
Philip Gould, Avamore Capital
New research by Avamore Capital has highlighted that SME developers are continuing to face major challenges in relation to sites stalling for financial reasons.
A year on from the 2020 FMB House Builders’ survey, which found 33% of respondents said that lending options had deteriorated YOY, and a staggering 42% stated that they were involved in sites that were stalled for financial reasons, Avamore Capital is reporting that this situation is the same, if not worse, and that demand for Finish & Exit funding is higher than ever.
A leader in principal development and bridging, Avamore has seen a 62 per cent year-on-year rise in completions of its Finish and Exit product, designed for part-built development projects; moreover, it claims indicators are that it show no signs of slowing, as the long term impact of multiple UK lockdowns remains clear.
Further research has highlighted four key reasons that are the most prevalent, or have had long lasting effects, which have resulted in the high number of projects arresting. These include: workforce instability and skill shortages, increased material costs, forced delays impacting agreed payback periods and likelihood of exit through sales.
“Whilst the property market has been fairly resilient through the pandemic, supported by government support packages, a number of factors have meant that many developers, although they were permitted to actually build, did not have the resources available to do so,” says Philip Gould from Avamore Capital.
“Various issues driven by COVID in the last 16 months have seen many projects fall behind and hit funding challenges – meaning they can’t meet market demand. Some developers found that they had to close sites completely with set-ups not allowing for appropriate social distancing measures, others were facing increased costs and most faced shortages of material supply. This combination meant that the number of developers obtaining cash out of their projects through sales is falling.
“Therefore, when planning for projects – and particularly as the pandemic wages on - it is important to pre-empt these intensified financing factors, which may impact timeframes, costs and ultimately profitability, and plan differently. We advise these steps:
Managing Workforce Stability – to reduce chance of running over term
The Q1 2021 Federation of Master Builders State of Trade survey highlighted that builders have reported increased difficulties in recruiting almost all the key trades in the first quarter of 2021. 38% reported bricklayer shortages, up from 22% in Q4 2020, and 34% are struggling to hire carpenters/joiners, up from 23%. The report attributes this to a lack of quality skilled entrants to the industry and increased loyalty to current employers.
“This means that projects could take much longer to recruit for than ever before and so, we may see more developers starting all of their processes earlier in order to ensure a strong construction team” says Gould.
“Around 10% of the part-built schemes Avamore has funded in 2021 have reported that difficulties arose directly from being unable to secure a strong workforce upfront. Therefore from a financing side, the danger of not setting up the correct infrastructure means that projects could take longer than planned and so, the developer could run over term.”
Review current material costs – so financing forecasts are based on real time pricing
According to the Department for Business, Energy and Industrial Strategy (BEIS) the overall cost of materials for new housing was 6.7% higher in January 2021 than in the same month in 2020. Another example is from the Timber Trade Federation (TTF) which found that a range of ongoing logistical and administrative difficulties related to Brexit have led to supply problems and price rises.
Gould advises: “With supply chain issues and costs creeping upwards, it increasingly difficult for developers to effectively plan their cash flow schedules.
“14% of part-built projects Avamore supported in Q2 2021 required specialist structures to maximise funds available as soon as the loan completed; this was for the developer to cover the cost of urgent materials on site. In development finance, a contingency is always added to the loan (a pot designed for unknown costs which developers might face), but it is advisable it should be avoided or utilised as late into the project as possible. Fixed price contracts for future materials or using suppliers who offer the certainty of delivery has become more important than ever. “
Consider delays and discuss loan extension options upfront
“With the impacts of delays and costs, developers may have either run out of their existing development finance facility or come to the end of their term. Any development loan is issued for a set amount of time and most lenders will be looking to be repaid as soon as that period has come to an end. It is therefore likely that most developers had to negotiate with their funding partners across 2020 to avoid a formal ‘default scenario’.
“Whilst the lending market may have been relatively lenient at the start of the pandemic, it’s unlikely that relying on short term funding flexibility will remain a prudent strategy. Developers need to stick to a timeframe but also factor in the potential that the pandemic and Brexit is likely to continue to have an impact on many industries.
“It is therefore important for developers to have conversations with funders upfront about the possible scenarios they could face over the life of a loan.”
Whilst Avamore Capital adopts a careful lending strategy, in the last four weeks it has extended £2,762,802 worth of loans for an average of seven months after developers faced COVID driven delays during the build and now need additional time to sell the units.
“Discussing options at the outset such as informal extensions, conditional extensions or reduced extension fees would be prudent to ensure that should the unexpected occur, developers are prepared to finish their project in a cost-effective way”, adds Gould.
Secure an exit - determining the stability of the end user is more important than ever
“A strong exit strategy has always been important but considering the volatility of the market and economic uncertainty, it is likely that circumstances at the end of projects are becoming increasingly less predictable. As the stamp duty reduction comes to an end the market is likely to be impacted.
“In Q1 2021, the average price of a unit completed by an Avamore borrower was £426,258. With the stamp duty threshold at £500,000 the number of potential buyers for those same projects is likely to have reduced by September this year when the scheme closes completely.
“It is clear that the government has implemented measures to plug this potential shortfall at the lower end of the market, policies such as the 95% LTV mortgages will continue to make house buying attractive but, it is almost impossible to determine whether these measures, which involve borrowing more, will have the same impact as significant cost savings.
“Understanding the end user and determining their stability is therefore more important than ever.”
Gould adds: “It’s important that everyone involved in the industry prepares for new challenges, including how projects can be financed and rescued should problems arise.”