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As the development finance market grows, caution is required14th May 2014

48 per cent of developers would choose reputation of lender over priceThe 2008 credit crunch paralysed the banks and seriously hindered many experienced builders and property developers through a lack of liquidity. As a result many good schemes were mothballed. Over the next couple of years, as the UK receded into an economic recession, the construction sector became severely constrained. It was not until last year that the construction industry has started to grow again, with house construction growing for its 15th consecutive month in April this year.

This is the longest period of continuous growth since 2006/07 according to the Markit/CIPS construction PMI. A poll conducted by development finance providers Regentsmead suggested that since 2010 there has been a 43 per cent increase in the amount of small to medium sized builders active in the UK.

One of the main attributes to this new growth in the construction and house building sector is the continued growth in the development finance market, which has enabled property developers more access to liquidity. A recent Knight Frank report on the development finance market has confirmed that 70 per cent of lenders expect to increase their level of residential development finance over the next 12 months. However property experts at Regentsmead have argued that herein lies the problem.

Prior to the crash in 2008 there was a similar sense of optimism in the market with many bridging lenders and short term financiers stepping into the development market because of the apparent opportunities of this growing sector. Fast forward to 2014 and we are seeing history repeating itself. Lenders with relatively little experience in this sector are now trying to become competitive on the products they are offering, giving developers an array of choice in rates when sourcing cash for their projects.

Interestingly, Regentsmead’s development finance poll showed that 48 per cent of developers would choose reputation of a lender over price when sourcing their finance. For long established firms such as Regentsmead the new optimism means fairly little in the long run.

Chief Executive James Bloom said: “We were one of few lenders that continued to lend right the way through the recession as we have done through the numerous economic dips in our 80 year history. It’s alarming that we are seeing more clients who believe they can shop around to find the best price and then end up coming back to us several months down the line having had bad experiences of lenders that don’t understand the sector. Ultimately these developers will lose money after their projects come to a standstill proving that experience is everything in this industry.”

According to the House Price Index from the Office for National Statistics, UK house prices increased by 6.8 per cent in January 2014 compared with a year earlier, up from 5.5 per cent in December 2013. When house prices are rising it is typical for lenders to start lending more to the perceived end value of the property, i.e. a higher loan to value (LTV) and this is where Regentsmead recommends proceeding with caution in the development finance market.

Although house prices are on the rise at the moment, there is no certainty that this will continue. In fact there is always a risk that house prices will fall, which could lead to problems in the future for those lenders who have over-exerted themselves and don’t fully understand the development industry.

If there is anything we can learn from the sub-prime mortgage crisis which happen in the US in 2008, it is that lending against the perceived market value of house prices can be a very dangerous game. One of the sparks which set off the 2008 credit crunch was the fall in house price values in the US. In this instance, a vast proportion of the US population had borrowed large sums of money against the perceived market value of their houses. When the house prices then fell, many people found that their debt was higher than the actual value of their house. This led to people simply vacating their house. As a lot of this debt was put into financial vehicles, these vehicles obviously experienced massive problems, which in turn had massive global implications.

While the signs of an economic recovery are evident in the market for development finance, property and construction, it is a concern that so many lenders are stepping in with relatively little understanding of the nuances of a development finance case. When another downturn inevitably happens it will be interesting to see which lenders are able to survive. 

About the author
Adam Bubb, RegentsmeadAdam Bubb is a new business executive at Regentsmead, where he arranges loan facilities for experienced property developers in the UK.


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