By Julian Sampson
Redrow Homes announced in September that profits and turnover are up: and a positive future for homebuilding in the United Kingdom. Brexit, now a few months ago, is (for Redrow) little more than a moment in time that has done little to deter progress.
The outcome of the EU Referendum was a surprise and a concern but, on reflection, our own response is markedly more positive: our lending clients remain tied to an asset-backed, secure environment, investing into a core property market whose fundamentals are utterly unchanged from the Brexit vote. As Don Steinbrugge, Managing Partner at Agecroft Partners, said in a Bloomberg interview recently, “If you’re an investor, and all your money is in equities and fixed income I think it’s time to try and diversify”. The first week of July saw investors endeavouring, en masse, to redeem interests in fixed income, open-ended real estate funds to such an extent that the fund managers had to restrict redemption liquidity. Whilst this grabbed the news headlines, it was more a tale of the investment structure than the quality of the investment class (real estate) that sits behind.
There are two key areas that impact the credit decisions of our lending and real estate investment community: asset fundamentals and capital market sentiment. In economic terms, Christine Whitehead of the London School of Economics feels that Brexit:
increased the risk and potential for inflation – with potential for interest rate rises after initial falls;
would bring some slowdown in investment and recruitment, possibly leading to recession and some considerable decline in activity in the housing market.
In achieving Government’s first objective - the macro-stabilisation of the economy - the impact will initially be seen on interest rates and credit constraints – and both are likely to have an adverse effect on the housing market. However (and this remains important), the underlying fundamentals of housing need and housing growth remain unchanged. In a superb piece of timing, the Home & Communities Agency has recently launched its Home Building Fund, providing £3bn to support house builders in England, £2bn focused on delivering infrastructure to support strong future pipeline of housing supply (targeting 160,000 homes) and £1bn for development finance to diversify and support innovation by supporting SMEs, custom builders and innovative construction methods (targeting 25,500 homes).
These are not signs of wilting appetite.
We know the market hates uncertainty, due to unquantifiable risks. However, it is rare for such uncertainty not to also offer opportunities. Sentiment is also key to the market and it is notoriously difficult to predict, especially in these circumstances and thus during such times it is best to go back to fundamentals.
The key fundamental is that there is a “structural undersupply” of housing in the UK market. This is reinforced by Redrow’s results. The recent vote does not alter that position. Accordingly a solid demand remains and this is especially true of properties in well-connected and desirable locations.
The availability of credit is likely to reduce and the cost of such credit increase. This is despite the reduction in the Bank of England base rate. This creates an even more attractive platform for any lending proposition into development. It should drive better quality partners and developers to the door of savvy lenders as funds become more difficult to acquire. Where a lender has a clear, robust and demonstrable approach to the selection of partners and deals, then this will give investors confidence to take advantages of any market dislocation and potential gap in the market.
The residential market will respond to the changes in the market and sometimes the granular nature of the market will avoid the “en bloc“ sentiment that can have an adverse effect on more cohesive sectors of the property market. For example, if prices are negatively impacted, the “discretional” part of the market will not proceed with marketing, thereby reducing the supply and creating a floor to the property values.
The London prime and super prime market tends to react differently to the rest of the UK. This market has been slowing since mid-2014 due to a wide range of reasons and few to do with the EU referendum. There is a general and understandable view that this market would be more adversely impacted. However, this to some extent, will be offset by other factors such as the relative strength/ weakness of the £ against the purchasing currency and ultimately the ability of the UK to continue to provide a “safe investment haven “ in prime London. This greater degree of volatility can be insulated from investors where it is not a target for the project investment or lending product.
The rest of the UK market is very different, with a different set of drivers underpinning the same. It is not immune from all of the above, but it should be well placed to adjust to the new circumstances and conditions. Should residential demand slow, to some extent, the over requirement of housing should absorb any perceived cooling to still leave a reasonable demand in place.
One of the potential impacts is a reduction of skilled construction labour from the EU. With a potential slight reduction in demand, these factors are likely to come back into balance in the medium term. However, as part of the risk reduction process, any development lender (or developer) should ensure that future partners are not building businesses based on short term expediencies of attracting an EU skilled workforce. It is recognised in this that those that limit subcontracting may well be better placed to fulfil this criteria.
The political and media scrutiny of Brexit will remain passionate and, at times, stark. The truth, however, is that we have seen more lenders launch in the last 12 months than at any other time since we have provided services to this sector: and with a £9bn shortfall in funding levels between 2007 and 2016, there remains considerable appetite to join in the post-Brexit development economy.
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