Building real costs into SME development

Build cost challenges have appeared in over half of welcome intro pieces at our Real Developers Boardroom meetings in recent months. 12 or so experienced SME’s explaining what’s really going on for them to their peers. Pressure, in one word.

What started as a gentle wave of increases in January 2021 grew into a tsunami of core item price explosions, as we have all seen. Very dramatic language, but as we all know, these hikes can have drastic effect on real residual land values, as played out below.

Last time, at the Land Boardroom by TrustedLand meeting, we focused on financial appraisals as the session for our various land sourcing partners. Why? Because so many private land owners, and seemingly formal land agents, still haven’t fully grasped the effect build costs is having on land values. Someone needs to educate. Their price mindset is still pre-2021, and not much is being communicated in the general press to adjust this expectation.

Martyn Pollock from Hallcroft Finance, one of the three brokerages on the TrustedLand Finance Panel, was invited in to share with the attending land sourcers, their comprehensive appraisal approach, apparently celebrated in the lender space for its thoroughness. One of the core discussion points: push back from monitoring surveyors on build costs before issuing terms.

Martyn gave the room very strong suggestions that they gather independent information to supercharge their justifications when presenting their developers offers, with the room accepting that commercial build costs hadn’t quite crept into the constant media coverage of house price growth, which land owners still often see as direct growth in land price.

We shared with the room, a recent survey of 40 SME developers from one of our South-east England land peers, showing that £180 – £210 psf was identified as the clear average new build rate for a basic product.

In our the aforementioned developer meeting two weeks prior, the room indicated £220 psf build cost was absolute minimum for a quality, mid-market family home to start.

On the opposite side of the coin, two different private portfolio land owners that we work at TrustedLand sent us their own site appraisals, showing assumed build costs of an average £160 psf.

Thats 17% off the entry level product mid-point, and 27% off the mid-range. The real result, to achieve the same profit margin for the buyer, we’d have the adjust the land value by a whopping 23.3% on the 75,000 sqft of new build homes and apartments. How easy do you think that reduction pill is to swallow for a landowner. Probably feels more like a suppository.

Construction challeges are the number one reason developments get called into receivership, and I am sure lenders are still all too familiar with the last big wave that crashed.

But are SME developers being forced to stomach and risk these hikes, estimated in some spaces as 30-40% blended increase in 12 months, to just stay in the development game? Are lenders entertaining reduced profit margins just to keep lending?

Andrew Hosford, who featured with me on the first four episodes of The Real Developer Podcast, gave me quite a timely lender insight off-air after one of our interviews together:

“The profit is being squeezed across the board and of course the ultimate hit is on the developer.

There are lenders that can reduce their own cost of funds, causing their profit margin to tighten a little but allowing the development to actually happen. It really depends on how they are funded and what the cost of their funds are.”

In the same breath, the Q1 to Q2 2022 land requirements data collected and published from our Real Developers showed a 31% increase in demand for consented sites, meaning more are looking and willing to take on the build right now, a statistic likely to be repeated outside of the TrustedLand walls too.

So, there is growing demand for consented sites, alongside significantly increased build costs, alongside heightened land values that dont seemingly want to factor the cost increase…it leaves a tricky predicament for developers and lenders alike.

Do we need to just keep calm and carry on buying and building? Does the space need to ease off the gas and wait for expectations to reset, and inflation to settle? If carrying on, who is picking up the additional risk, and associated costs?

After his recent podcast recordings, Dean Brown of our third finance panel brokerage Aureum Finance, shared with me and our guest:

“Unfortunately the rising build costs have not seen a reduction in land prices because land owners are still in a strong bargaining position.

The planning process has only deteriorated further during Covid and this has caused a significant shortage of viable development sites, so until the planning landscape improves, land owners can simply wait for the price they want.”

The next Land Boardroom will cover off build cost activity in more detail, after which I’ll come back and share the insights alongside the newly published Q3 Land Requirements for the Real Developers.

In preparation, your comments on underwriters approach to build costs estimations would be welcomed. As we all have a vested interest in stable development continuing, we need to ensure we’re on the pulse wherever possible to help support out clients as intermediaries.

Alex Harrington-Griffin is CEO at TrustedLand

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