25 Mar The land owner, the developer and the potential shift in power
- Brexit uncertainty is driving down GDVs, pushing up build costs and causing developers to increase profit margins
- A combination of these factors contributes to softening land values
- Whilst land agents have reported some downwards pressure, not all owners are in situations where they need to sell
- As developers draw back on the amount, they are willing to pay for land, the market may experience a ‘buyers strike’
- Consequently, in the short term we may experience a drop-in development activity (and therefore development lending)
- In the medium term, this is likely to cause a fall in new home starts and we could see spikes in house prices in 18-24 months due to constricted supply
The 2019 property market paints an unclear picture. Whilst the UK economy has weathered much of the Brexit uncertainty up to now, there are increasing signs that the housing market and wider economy is starting to feel the strain. Evidence across many regions of the UK suggest a softening of GDVs, set against a backdrop of increasing build costs (due to the weak pound pushing up material costs and fewer available workers leading to increased labour prices). Consequently, developers are factoring larger profit margins into their appraisals providing an additional buffer for unforeseen changes.
This is expected to reduce land values and so presents a potential shift in the balance of power between the land owner and the buyer. For those that are under pressure to sell, it is likely that they will drop prices. For those with low holding costs however, it is expected that they will ‘land bank’ until there is a market correction. Regardless, there will, to some extent be a change in the market dynamics; the significance of this evolution however, is difficult to predict.
Land agents are divided on the state of the market. David Marsh(Managing Director, Landsource) reported positively in favour of land values holding up specifically in the southern home counties, stating that good quality sites will always be difficult to obtain due to the limited supply. In contrast, Daniel Minsky(Director, Estate Office) commented that although there is less development land stock and fewer consented sites at the moment, prices are either stagnating or falling and it is becoming a ‘buyer’s market’ to a greater extent. Some developers are remaining opportunistic with fewer being prepared to pay over the odds for sites until there is more Brexit certainty.
Additionally, valuers such as Simon Millsfrom Kempton Carr Croftare assessing sites and concluding that GDVs are much lower than in benign economic environments. These judgements are contributing to a nervousness in the development market. Borrowers still feel that the next year is a risky one and so, they are compensating for that trend. Immanuel Ezekiel(Director, Broadwing Homes) commented in a recent video interview with Avamore that he is “building in greater profit margins to justify schemes and safeguard [himself and his investors] against any negative impact that Brexit will undoubtedly cause”.
What comes next? Firstly, developers shouldn’t expect a sea of ‘bargains’. There are very few landowners under pressure to sell, especially in a low interest rate environment. Most consented development sites are controlled under long-term options or were bought unconditionally and will have very little debt attached. Land with planning consents due to expire can usually be renewed too.
Accordingly, if the landowner’s price expectation is not met, then the land will not sell. The only exception is if the landowner is distressed, holding too much debt against the site or they are facing situations like probate sales. This imbalance could lead to a “buyer’s strike” and a drop-in activity levels driving an intervening period of market stagnation.
The impact on lenders
The short-term impact for lenders will be two-fold. Many bridge lenders hold loans secured against development sites which may now see their LTVs under pressure. Development appraisals on these sites may no longer work and we may see a rise in repossessions and receiverships.
Additionally, with fewer sites coming to market and being sold, we will also see a fall in the amount of new development starts. Some of this may be partly offset by landowners developing sites themselves rather than selling it for profit, but overall the situation could cause a net fall in originations. A knock-on effect of this will be a further constriction in supply of completed units in 18-24 months, which will put pressure on the end-user market, reducing housing affordability through price and rental spikes. These spikes will feed back into development appraisals and land values will start to recover as a result.
Land values for all but the most important and strategic sites are under pressure due to soft sales prices, rising build costs and developers baking in higher profit margins for protection. As few landowners are being forced to sell, developers should react to anything that looks like a ‘bargain’ as things could turn more positive in around 18-24 months and so starting on site in the next 6 months could be good timing. Notwithstanding that, the next 12-18 months looks tricky for those involved in lending against and trading in development land.