Development Finance

One thing I often discuss with colleagues is the use of the term ‘old school’. I like it. I take it as a compliment. I see it as a nod to having learnt and taken heed from past experiences. Most of my colleagues at Magnet Capital, like me, were trained at a previous lender that had been successfully lending money for several decades. Our schooling was in the fundamentals of lending; being measured, being considered and being the tortoise and not the hare. If you can balance this with an unparalleled service and a commitment to lend whether the sun is shining or not, then you have the makings of a very successful lending business.

However, over the last decade I’ve closely admired the transition of the specialist finance industry from ‘old school’ to ‘new school’. There have been many changes in how things are done and don’t get me wrong, I’m a huge advocate of innovation and finding new ways of doing things. Innovation is one of the key areas that will determine which business will be successful in the coming years, but perhaps as we move into testing times, with undoubtedly choppy waters ahead, we can navigate our way through as an industry by looking to the past.

Lending fundamentals are now going to be more important than ever. Cutting corners and taking unwarranted punts on the asset in question is probably the most common fools’ folly I’ve seen in recent years. As lenders we are all keen to grow our loan books and beat the competition. However, I’ve seen many recent cases where we’ve been asked to push our normal lending parameters to win a deal. Whilst we’re undoubtedly committed to servicing our broker partners, it’s this sense of needing to ‘chase the market’ that can really hurt lenders. Looking back at the 2008 financial crisis, the worst hit finance businesses were the ones that were happy to take on too much risk and cut too many corners when the sun was shining. This is even more true in the development finance sector which is inherently a higher risk style of loan.

There’s also the factor of top down pressure which can lead to lending errors. Some lenders have large instances of non-utilisation fees. This coupled with high business overheads can put the lender under pressure to make risk-based decisions that they wouldn’t normally do. Turning down business because it’s perceived as too high risk, or an unflattering return for the business is always a hard decision to make. My fear at the moment is there are still lenders lending money on behalf of private investors or institutions making decisions that aren’t feasible in the current economic climate.

One of the only ways to judge the future is by looking to the past. Property markets are intrinsically linked to the economy. The economy as we know moves in cycles, and we’re undoubtedly entering a period of great uncertainty and potentially huge economic difficulty. Unfortunately, even the so-called experts are unable to make accurate predictions. So, as lenders, we need to continue to back our brokers and the consumer. If this means giving up business and taking less risk, then so be it, but as I’ve said before now more than ever is it important to be consistent. There’s a great saying that I learnt during my time living in China and that’s ‘crossing the river by feeling the stones’. This idiom about moving forward whilst being cautious couldn’t be more pertinent to the specialist finance industry today.

It felt like the chains had been unshackled, as I stepped out of my car, in bright sunshine, at one of Magnet Capital’s development sites last Monday morning. For the first time in over eleven weeks, I was able to do what I enjoy most; visit our projects, see how they have progressed and chat with our developers and their team.

Except it wasn’t normal, I was sweltering in a mask and gloves, despite being on an open-air site, with the two bungalows at wall plate stage. I took my position a good two metres away from the developer, whilst the rest of his team were mostly at home, except for two labourers distancing in a corner of the site. Despite all this, the client was delighted to be back on site having lost a good six weeks due to lockdown, closed suppliers and scarcity of labourers. Thankfully roof trusses and windows were soon to be delivered, so that the site could continue with no delays. Roof tiles from Spain were causing an issue but he had a work around and frankly he is one of the lucky ones.

Across our extensive range of development sites at Magnet Capital, we have heard of difficulties for developers in getting bricks, block and beams and specifically those building materials, which require bespoke factory settings, such as windows and roof trusses. Factories are starting to open up but there is a backlog of orders. To comply with social distancing developers are faced with having only a skeleton crew on sites, which will be magnified when the properties are watertight and are working on internals. Hand sanitiser, cleaning of surfaces, face masks will all be necessary. Delays and rising costs are a reality for all our developers. As a development finance lender we have to be realistic that our clients projects will overrun their loan period and we need to help them either to extend their loans or source developer exit products.

The new normal is also opaque as to what will happen to the property market in terms of house prices and the mechanics of selling new build properties. There will undoubtedly be far-reaching economic ramifications but at the moment there is plenty of pent up demand. The Government’s lockdown measures resulted in an estimated £82 billion of house purchases placed on hold. Some early indications suggest that the market is springing back into life, with Rightmove stating 40,000 new sales having been agreed since 13 May and it saw its ten busiest days ever in May and June.

We are all going to be spending more time in our homes and spacious properties with gardens and nice views should be in demand, whereas flats in high rise blocks, requiring lifts and in urban areas with little outdoor space, might struggle. This could be accentuated by people increasingly working from home, with less need to be in urban areas, close to their place of work. The commute will become less of a burden on the psyche and the pocket, if people are working from home a couple of days a week, meaning that more living space, further out of the city centre, becomes much more desirable.

Agents will need to find ways to cleverly market their properties, offering virtual imaging cameras to create accurate floor plans and 3D simulations of properties, or filming short video tours inside. Potentially the new build market will outperform the second hand market, as the risks are lower visiting a vacant rather than occupied dwelling. The mechanics of buying and selling is further complicated by the difficulty in the current climate of getting valuations, surveys, searches, and dealing with the Land Registry. Sellers need to get all their paperwork ready and buyers need to ensure that they have a decent solicitor that is not stymied by working from home and surveyors that are willing and able to attend the property.

Last week felt like the mist was lifting and a sense of normality is returning, However, all we can do is take each day as it comes, as looking too far into the future of the property market is unwise in the best of times and especially in current times.

As I sit working from home with the news on a constant loop, the picture is forming of a dystopian world where  from a corporate perspective there will be few thrivers, aside for big tech, and the rest will be competing to be survivors.

Undoubtedly, the world is facing a crisis like we have not seen for probably a 100 years, and the impact on people’s lives has and will continue to be unprecedented in the short term. Reports are suggesting there will be a wave of soured UK commercial property loans, owing to the slump in retail property. Indeed, from the development finance perspective, restrictions on movement, the closing of building suppliers, the effective shut down of the residential property market for sales and rental has and will lead to serious delays. With regards to residential property, I believe this is overly bleak and once a vaccine and suitable drugs have been discovered, the UK’s passion for property will return.

However, whilst running a development business from my home office, in between Zoom calls, reviewing drone footage and photos of our sites, I wanted to do a bit of stargazing to see what changes for the better or worse might affect our industry. Clearly, I have no crystal ball but just a deep interest in the development finance industry.

An argument that is raging at the moment is whether Covid-19 will lead to a rise of nationalism over globalism. Given that the UK imports significant amounts of building materials, with one fifth coming from China, should the UK be focusing on ramping up domestic production? Whether it is electrical wiring, softwood timber, clay tiles, there is an argument that the UK should be fully self-sufficient. My guess is that there will be a significant move to on-shoring capabilities where possible, although of course some countries are better endowed with natural resources than others and we will still import where there is little alternative.

We are all starting to use technology more in our day to day roles, whether that is utilising: valuation software, drones for building inspections, or zoom sign up meetings. Therefore, shifting the belief that development finance underwriting can’t be automated and that the borrowers need to be met in person and the sites visited. With regards to the surveying profession, whilst physical valuations will still be necessary for the majority of development schemes,  we will see a degree of change , with more virtual monitoring inspections. However, this is likely owing to the rise of modular housing that will reduce the need for so many physical monitoring inspections, rather than Covid 19.

From a lender’s perspective no matter how much a system can be automated, you still need a human to make decisions and review the due diligence that the computer programmes produce. Face to face sign up meetings with the borrowers are crucial to assessing the risk of a development project. Yes ,you are also looking at the valuation information, the site details, cashflow, business plans etc but ultimately you are backing the individual/individuals. At Magnet Capital, we will be reinstating this, of course adhering to social distancing rules, as soon we can. So, don’t get rid of those meeting rooms just yet.

Which leads me on to the question of working from home. It is one that the industry has struggled with for many years. The mantra of management has always been, that you need to have your employees in the same physical space, to create the optimal working environment. The reality is that with modern technology it is possible to work efficiently and productively, without being in physical proximity.

Whether using slack, zoom, dropbox, xero, alongside a business’s existing databases, the ability to work remotely is, if not seamless then close to it. Avoiding the daily commute, not being crammed into a hot desk environment with little natural light, and having the ability to work flexibly is attractive. Now, I am not suggesting that office space is no longer needed but I think there will be a realisation that big expensive offices might need another look. It is of course about having the right systems in place and yes it is easier with a small team such as Magnet Capital’s who have all worked together for many years rather than a giant multinational.

The modern office will be reshaped, with perhaps meeting rooms and desks for those who need to be in rather than paying for a space for hundreds of people. And just a thought – perhaps from a residential development finance perspective, there might be opportunity for developers to turn the unused office space into flats.

To borrow a well worn but largely derided phrase in the financial markets that “this time is different” but I think in some ways it possibly could be.

It says a lot about the rapidly changing face of our market that the data produced by Ernst & Young,
changes significantly year on year. Now in its third year, the annual EY Bridging Market Study is one
of the widest data samples that we have for the short-term lending industry. It is also unfortunate
that the survey was conducted just before the Coronavirus pandemic started to hit the UK and I’d
implore the good people at EY to perform a follow-up study on their short-term findings later this
summer.

We have undoubtedly entered a period of short-term uncertainty and the true impact of
the Coronavirus on our market will not become completely apparent for some time. We can,
however, look at their long-term results with great interest and we can also look back at what
lenders and brokers have reported about 2019. Here are two key areas:

A crowded space

Interestingly, 67% of those surveyed reported that they have found competition increased in the
bridging market in 2019. Similarly, an increase in competition was cited by lenders as the biggest
challenge ahead for 2020. At Magnet Capital we have also seen a proliferation of lenders moving
into development finance, which I suspect is an overflow from what is now a very crowded bridging
sector.

From my own experience I’ve noticed from conversations I’ve had with other lenders that an
overcrowded space has been on everyone’s minds for some years now, and yet every year we seem
to be adding new entrants. A growing market should allow for more capital deployed (not
necessarily more lenders) but considering the effects of Coronavirus, surely we’ve now reached a
point where lenders will either need to exit or merge?

I did also spot a brave new face entering the bridging market just earlier in April 2020 and my hats off to them! Competition has historically pushed lenders to lower rates and higher up the risk curve. Respondents confirmed that average monthly interest rates were lower in 2019 than in the previous year, and LTVs were higher. Having reached the peak it will be interesting to see on what other battlefronts lenders will compete. For me there is one clear area that stands out.

Are we bit old fashioned?

One of the biggest trends seen from last year’s survey is the continued prominence of technology in
our sector. Some 39% of respondents now believe that open banking would significantly improve the
obtention of new business, and this is in addition to the use of AVMs and further automating of the
underwriting process. It’s somewhat apt that in the current crisis use of technology is now a
necessity rather than a luxury and I expect the pandemic to accelerate the need for lenders to invest
in their tech.

At Magnet Capital we focus heavily on our internal technology in order to streamline
the underwriting process and this has been a primary source of focus since our inception.
Conversely, I’ve always been a big champion of old fashioned lending practices and there is
ultimately no replacement for face-to-face to meetings with clients and a first-hand inspection of a
project or a property (no matter how much we’re all enjoying Zoom conference calls at this time).

This is also taking into account that 52% of lenders noted refurbishments as being the primary use
for bridging loans. This inherently raises the challenge of bridging lenders needing to be even more
hands on in a business environment that is still learning how to remain socially distant.

They say the construction industry is the first to enter a recession and the last to exit. I use the ‘R-word’ reticently in that we are nowhere near understanding the true implications of the current Covid-19 Crisis, on values and on the wider property market.  The last few weeks has seen various lenders pull product ranges, with development finance being one of the hardest hit sectors. However, as of today government guidelines do not prohibit construction or activity on construction sites, as long as public health guidance is being followed. In fact, across many of Magnet Capital’s development schemes that we are funding, progress is still excellent.

We are seeing a hard-nosed resilience that was perhaps born out of the destitution of what many builders and construction firms went through after the 2008 crash. In fact, just today I conducted a wonderful virtual inspection of a large site we are funding in Kent which was full of activity, with an appropriate number of tradesmen on site that are respecting the social distancing guidelines. Naturally, we do have a handful of clients that have closed their sites and in many cases this has predominantly been down to our clients need to protect vulnerable relatives at home. We have also seen many complaints about supply chain which the government is yet to sufficiently address and could cause further disruption beyond the Coronavirus crisis.

Beyond all the usual struggles for SME builders and developers, access to appropriate development finance will now become a serious issue. I say appropriate because for every quality development finance lender, there seems to be a handful trying to cut corners in our market. The landscape for development finance has changed dramatically in recent weeks but the one thing the development finance sector needs now more than ever is consistency. Having what I call a ‘Hokey Cokey’ approach to financing, where lenders decide to be in one minute and out the next, can be hugely detrimental to our sector and damaging to reputations. Consistency is key because it breeds confidence, which in turn trickles down from our brokers to the consumer.

The development finance sector has come a long way since the 2008 crash and indeed since I joined the market in 2012. It’s a small world and I really enjoy sharing thoughts with competing lenders and being able to speak candidly with our broker partners. One thing I think we can agree on is that this is very much a pull-up-your-socks moment for the development finance industry.

At Magnet Capital we have always been known as being a cautious lender and years of being conservative in our lending means that we are currently in a very strong position to serve our brokers and our clients. Having a sudden nose-dive in liquidity in the sector will undoubtedly cause serious problems for the wider property market far beyond the Coronavirus Crisis. Let’s keep doing what we’ve doing for years and continue to back the construction sector; they’re going to need it.