Despite steep downcycles, the property development sector can win new opportunities in 2023

I recently co-hosted a roundtable with Hilltop Credit Partners , to discuss current and future challenges for the real estate sector. We covered everything from market supply and demand, the challenges of lending in cycles, and of course, the impact of inflation and economic uncertainty. While there are no doubt hurdles ahead, I am still optimistic that experienced developers can come out on top, so long as they have the right leaders and lenders behind them. Here’s why…

High interest rates aren’t to blame for sector challenges

It would be easy to claim that high interest rates are the biggest blocker in the industry right now, but that would be reductive. We’ve seen rates like this before, if not higher. Pre-Great Financial Crash (GFC) rates averaged at 6%, but for ten years we’ve been at historical lows, so it’s fair to say we’ve become used to cheap money. A lot of people have never had a mortgage above 2%, so naturally, when they see mortgage rates at 6%, they’re shocked – it’s not something they necessarily factored in.

But I don’t see the problem solely as a rate problem – it isn’t. The problem is uncertainty. If we knew that rates were going to remain stable at 4.5%, or even stay at a high of say 7% for the next five years, businesses and consumers could plan for that. A sense of certainty and lack of constant fluctuation are what help businesses and consumers borrow responsibly.?

But unfortunately, we’ve had a sustained period of instability which reached a peak immediately following the Truss / Kwarteng mini budget, which temporarily plummeted the pound and diminished market confidence in the British economy.

What we saw with that budget was unique in that fiscal and monetary policies were effectively at odds with one another. The swap curve blew out and the Bank of England was hard at work undoing the impact of the then Chancellor, hiking up its base rate nine times over the course of a year, in a bid to curb inflation.??

That’s what the market hates. As a lender, you can work around other things. Inflation is managed with higher contingencies; you can shift from 10% to 15% to add a buffer zone just in case things spike. For interest rates, you can model an extra percentage point or 200 basis points. But can you model 500 basis points? It’s highly unlikely – the development scheme would have to be incredibly profitable to pull that off.

A short-term blip shouldn’t alter a long-term outlook

When it comes to supply and demand in the property market, it goes without saying there’s a complete unbalance. The housing crisis in the UK has come to a head, with student housing ‘reaching crisis’ point according to the Guardian . This means there is a lot of opportunity for strong and capable developers to keep building innovative, sustainable, and affordable housing.

There’s also still some liquidity in the sector now – although perhaps not for some of the new players that entered real estate looking for an easy ride and a quick dime. But those that have been in the game long enough will have weathered this storm more than once. They’ll have learnt from past experiences and come well-armed for the next bout of turbulence. That experience can’t be bought, and coupled with a strong leadership team, will help established developers capitalise on exciting new opportunities.

Boomerang banks will stall the housing market

Despite all the uncertainty mentioned, we do have sight of the end of the recession. If all goes to plan this year, we’ll see things level off around 2024. But what we cannot do, is let new developments fall off for another year. We know that without financial backing, experienced developers will lose out on huge opportunities, and as a result, families and communities will bear the brunt of it. More and more lenders are rescinding from the sector, which only serves to worsen the already huge housing shortage. At OakNorth, we don’t take this boomerang approach, bouncing back into markets in the good times and out again when they get tough.

Leveraging data to make smarter credit decisions

Lending in a down-cycle is no doubt tough. But, if done responsibly, it’s the right thing to do. You must underwrite harder, you need a bullet-proof credit team, and you need to run a lot more sensitivities, but these are all things good lenders do on rosy days too. We have some incredibly talented and tenacious partners that will rise to the challenge and look for ways to accelerate their growth while their competitors stall – and as their financing partner, it’s our duty to help them drive this ambition.

We’re a bank that was built on technology. Back in 2016, we became the first UK bank to become fully cloud-based, a landmark that paved the way for new regulation and innovation. Since our launch in 2015, our credit process has been led by a forward-looking model - we can map scenarios using thousands of different data points to make decisions quickly, consistently, and with extreme granularity.

What makes us unique in the end is the people that interpret the data. We have experts on the ground that know the sector like the back of their hand, and that are only a call away at any point when things change course. That’s what makes OakNorth a truly differentiated alternative lender.?

If you’re a talented developer, SME housebuilder, or investor looking for a financing partner that understands your market, feel free to connect and send me a message, or email me directly at [email protected] .