Over the last few weeks, I have written about the material change that has occurred in the world of late, namely the repricing of money, the fact that business owners are now struggling to pay their bills, the chronic inflation problem, and then last week, I was talking about the fact central banks keep getting things so wrong.??All heavy-duty topics I know, but unfortunately this is the terrain we are now in, and if you have been paying attention, it unfortunately doesn’t look like things are going to ease up anytime soon.
This week I want to touch briefly on problem, so many people are now struggling to come to terms with, and that is the area of development finance.
Traditionally, the vast majority of this debt, would have been provided by the main stream banks in Ireland, but since the Crash of 08, the Irish banks have become, very much, a bit part player at best in this space.
What has happened over the last ten years in particular, is that the vast majority of the funding for local housing projects for example,?has been provided by what are now well known as the “Alternative Lending Market”.
These lenders have been extremely well capitalised, and have demonstrated a willingness to lend to local companies, which to be fair, has facilitated the development of a huge number of residential developments across the country, in the last few years.
It would be remiss of me not to also mention the important role, private investors and local family offices have also played in the provision of funding for development locally.??These investors, have been lending money to builders and developers for many years now, often getting a coupon on their money, and depending on how the deals are structured, often a slice of the upside.?
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For the most part, most of these ventures have worked quite well, and it’s a system now tried and tested, and one I expect to continue to play a significant role in the provision of funding in this space.
WHAT HAS CHANGED?
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As we came out of the pandemic, around the start of 2022,??liquidity and appetite in the debt markets was particularly strong, and the willingness from lenders to support developers was still quite high, both from the Alternative lending market, and that growing cohort within the lending markets – what I have referred to above as local investors / family office money.??
If you required funding for, say a housing project in N Ireland, which benefitted from having full planning permission, the cost of funds typically would have been in the ballpark of 8% plus fees around the end of 2021, start Q1 of 2022.
Today Q2 2023, the cheapest development finance in town is now double digits, and this is only available from some of the main stream pillar banks.
The challenge of course when dealing with the local banks in N Ireland, being it could take up to 12 months to get the money off them, which for many people, they simply do not have the time or the patience to go through that particular process.??
Across the Alternative Finance markets, we are seeing a variation of pricing coming through, but it would be fair to say that most of rates are falling in the ballpark of 12-16%, in the vast majority of deals, we have seen in the last few months.
I appreciate I am pointing out the obvious, but when money is priced at this level, often it is eating into the margin of the builder / developer, at such a rate that it becomes no longer viable to build out the project.
In Q1 of this year already, our teams have looked at a number of projects for our clients, but when we modelled the cost of funds for the projects, they simply do not work.
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This is a major challenge for the developer / builder, as if they cannot build out schemes, which are profitable,??the knock on effect right through the industry is that less development takes place, less people are required to work, and less housing stock is available for a market, that is already thousands of houses short every year, to simply keep up with demand.?
WHAT IS THE SOLUTION
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The reality being there is no quick fix to this, as we are currently living in an environment where the trajectory of interest rates is up, not down.?
Many of the lenders operating in these markets are all now pegging their cost of funds to the base rate.?If rates continue to go up, then the cost of funds goes with it.
The smart money is on rates staying around 4.5% for another six months,?and maybe in the next 18 months might move back down 150base points to 3%.??
Until this happens and some stability starts to return to the money markets, and the world in general, we are all going to have to get used to money being that bit more expensive.?
Creativity
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Some of the best builders/developers I know, are also some of the most creative, entrepreneurs I know, and I do know that these kinds of people are always trying to find ways to fund deals and to make them work.
It is important to say that there are always a range of ways to get the funding to work, and my sense is that for as long as money remains expensive, we are going to see more joint venture arrangements, site find deals, and equity participation in the development world, as we move forward.?
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I think the other outworking of this is that more people are simply going to move sites and development ground on, as building them out, doesn’t work anymore.??
I am already seeing this trend play out in NI, and I expect it to continue throughout the rest of the year.
What about Commercial?
I have focused on residential development in this piece, to make my point, but the same challenges, if not more are afoot in the Commercial development Finance world.??
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For me, the bottom line is that unless commercial development projects are de-risked by way of a pre-let or some other contractual relationship with an end user/exit, then I do not see much commercial development occurring in a high interest rate environment (anywhere).
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Already in Belfast we have a number of fantastic buildings, which have just been handed over, either newly built or completely refurbished, sadly with no tenant, end user.??A nervous time for the owners and their funders I suspect.?
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If any of my clients are trying to source development finance for a project, get in touch with me.??
Our team is working everyday, trying to source funding for a wide range of projects, across the country, and we still do have quite a few funders who have an appetite and willingness to provide funding.?
Is it challenging – yes it is, but important to remember, nothing is impossible.?
Have a great week,
CD
Conor Devine MRICS,?has been working across the property, debt and funding markets for over twenty years, and is passionate about helping others in the industry overcome challenges and to reach their business goals.?
