Kick-starting the development finance market

Amit Majithia is principal at Avamore Capital

The COVID-19 crisis saw the UK go into lockdown virtually overnight; despite warnings from other countries, nobody was prepared for what the economy was to face.

The development finance market, like most others, was hit hard.

Restrictions on movement meant that work on many sites was suspended, and supply chains slowed or were halted completely.

This slowdown presented challenges to many development lenders’ loan portfolios, particularly if they were highly leveraged, and operational difficulties in getting valuers and monitoring surveyors to sites made it virtually impossible to close any new business.

Funders sitting behind lenders were naturally cautious,0 and so the market faced a near standstill situation.

After almost 12 weeks of lockdown, the first phase of easing has encouraged workers to return to sites.

While activity has accelerated, and will continue to do so with further easing, there will be a short to medium-term impact on the market.

Developments have fallen behind forecast schedules, and this will continue to impact the funding market, with more developers running over terms and potentially over budget.

The market is far from its pre-COVID status.

Historically, a feeling of confidence is the driving factor that underpins any market recovery – this will feed into lenders lending, borrowers investing and developing, buyers purchasing finished units and high street banks helping finance those purchases.

Financial market turmoil has abated for the moment, but the sector will also be dependent on developers’ appetites to start building again, and lenders moving closer to their pre-COVID product range.

These more tangible factors which will contribute to market recovery will be conditional on:

The ability to re-start construction

Many larger construction firms have already made the decision to allow workers to return to site, with social distancing measures in place.

Re-opening supply chains to service developments will be important in the weeks ahead – there is a potential for a spike in demand for materials as construction firms regain momentum.

If supply chains have not fully recovered themselves, this may lead to a lack of availability of some items or an increase in prices – both of which could impact demand in the development finance markets.

Administrative processing

Functions such as HM Land Registry, local planning authorities, building control inspectors and conveyancing firms all need to return to normal so that applications for registration can be dealt with quickly, planning conditions discharged, build control sign-offs dealt with and buyers are able to purchase developed units.

Administrative delays can be long and costly in normal times; developers will need to face as little friction as possible to play their part in re-starting the market.

Open market sales

Some uncertainty stems from the depth of demand in the underlying property transactions, post-crisis.

Completions of deals agreed pre-lockdown will not suffice, as there is too much sunk cost bias to pull out of transactions.

Development lenders will need to see deals agreed when restrictions are eased and completed on, which valuers can then use as comparables before the short-term finance market will look anything like it did in mid-March.

Long-term funding

More than ever, developers will need secure exit strategies in place.

High street banks are slowly returning to normal lending for homeowner and term investment loans, and once this has happened market wide it will support a return to normalisation.

Limited increases in unemployment (which will be reliant on a low number of furloughs turning into redundancies), a normalisation of movement allowing all key stakeholders in the development process from planning to construction and sales, and returning buyer sentiment will be key to lenders’ confidence returning.

For the time being, prices and leverage will remain conservative; for any new development deals, there is the risk of the unknown to consider over life of the loan.

The possibility of a second spike also cannot be ruled out, with another lockdown imposed; being mindful of that will be really important for new transactions.

For the moment, we are seeing cautious signs of a pick-up in activity.

On the developer side, we are likely to see a number of distressed or part-completed developments needing a new source of funding.

This is likely to be followed by a slow but steady ramp up in the amount of new development transactions that filter through to lenders.

Lenders will keenly watch for when valuers can say with more certainty what the effect on the pandemic has been, both in terms of pricing and liquidity.

Kick-starting the development finance market will be a collective effort across the board; evidence of stabilisation, stimulus for developers (including possible stamp duty reforms and VAT holidays) and clarity for lenders will all be responsible for driving a recovery.