Complex markets force investors to get creative for better returns


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The UK property market has never, arguably, been harder to read. And this is particularly true where residential property is concerned.

Massive pressure for new housing and lots of potential investor capital should be driving large amounts of development, but the picture is complex.

The key underlying issue is land value, which has bolstered house prices in many areas and continued rises in others. But against a backdrop of flat or declining real wages for the majority of workers and continuing caution on the part of mortgage lenders, many buyers simply cannot afford house prices in their area, even if prices are stagnating.

“It’s a real headache for residential developers,” says Adrian Leavey, real estate investment partner at Trowers & Hamlins.

"The market is largely flat, but disturbingly peaky. There are pockets of real forward movement, but some holes, and it’s quite easy to get caught out, find yourself exposed and go bust.”

Residential developers usually have a “get in, get out” attitude to investment, but there are signs that some are trying to change their business model in response to market uncertainty, focusing more on longer-term, guaranteed revenue, even if the margins are lower – a pattern more usually associated with institutional investment.

And that goes hand in hand with a change in institutional behaviour.

“We have seen a couple of institutions getting further into the deal, getting ‘dirty’, if you like,” says Leavey. “They’re not getting in JCBs and doing the digging themselves, but we’ve seen them buying sites direct and taking on some of the risks affecting developers, such as cost or time overruns, and effectively using a developer as main contractor. That means lower returns for developers, but without a lot of the risk, and the reassurance of a large fund behind them.”

Partnering more closely with institutions could also benefit developers combatting other obstacles, such as a dearth of skilled builders, electricians and other construction workers (especially in the capital), a brick shortage and the drying up of cheap steel imports.

“Unpredictable supply of labour and materials means delayed projects, and that means delayed returns,” says Leavey. “That means developers need to be looking in every direction at once, not only making sure they’ve got funding in place but considering resources, labour supply and, of course, the perennial planning issues.”

Despite rumours that the government was going to relax planning around residential development in order to ease the housing crisis, Leavey is sceptical that much will change very quickly.

"There are so many interested parties when it comes to planning, and so many regulations that don’t necessarily fall directly within the ambit of the local authority planning department but which can have an impact on a planning process, that I don’t think we’re looking at the floodgates opening.

“I think what we will see is more creativity around the edges, for instance a relaxation of the rules around self-build, which can be a very attractive option for those on a budget. I suspect we’ll also be looking at a lot of pressure for redevelopment, particularly of sites in the public estate which can be densified.”

Leavey’s view is reinforced by a recent report – Completing London’s Streets – by surveyor Savills, which calculates that around 20% of London’s 8,500 hectares of the capital’s local authority public housing estate, built in the 1960s and 1970s when London’s population was in decline, could be redeveloped and densified, providing up to 360,000 new housing units.

“We may also see a few ideas from the past resurfacing,” he adds. “For instance, with some developments in the 1950s and 1960s, the developer had an ongoing rent interest, which, with inflation, became nominal, but at the time was reasonably significant, and acted as an incentive to build and saw developers get a stable return over many years – effectively a ‘builder’s pension’! With uncertainty the watchword in all quarters, any initiatives designed with a view to the longer term will, I think, be very attractive to those companies looking to give a solid, but not necessarily spectacular, return to shareholders.

“Complexity forces creativity,” he says. The trick in this market is to look at more creative structuring, partnership with other organisations and type of organisations and the ability and willingness to take a broader, longer-term view of projects.”

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