July 14th, 2023

Navigating Change and Challenges

An Overview of the Economy and Development Finance Landscape in Q2 2023

By Jonathan Witter, Development Monitoring Director at Assetz Capital

The second quarter of 2023 has been a wild ride in the economy and property finance industry. Inflation and interest rate hikes have shaken things up, impacting the housing market. The housing market has been affected by the cost of living crisis and increased mortgage costs, resulting in negative impacts on house pricing and activity. Housing supply remains inadequate, potentially impacting prices. The build-to-rent sector is gaining attention as an alternative, with increased demand and rental growth. Developers are focusing on meeting the Government’s target for minimum energy efficiency ratings. Safety concerns, particularly asbestos in older buildings, must be addressed during conversions.

Let’s take a closer look…

Where is the economy at right now?

For those of us in the development sphere and property finance industry, the second quarter of 2023 has once again delivered continued change and challenges! In stark contrast to the views of some doom mongers the wider economy narrowly avoided recession with UK GDP increasing from -0.1% (Q3 2022) to 0.1% in Q4 2022 and again 0.1% in Q1 2023 (release date 30/06/23), which could be seen as an achievement, given the latent effects of Covid.

However, in Q2 the effect of inflation still running at 8.7% (May 2023) has fuelled two successive interest rate rises to 5.0%, in an attempt to tame inflation. Furthermore, the possibility of a further rise this year does not now seem so far-fetched, although historically it is worth remembering that interest rates are still in the realms of ‘normal’.

What’s happening to construction prices?

The effects of heady inflation on construction materials seen in 2022 appear now to have receded somewhat. The impact on some schemes was significant and remains as they edge towards completion in 2023. For developers, this means the respective impact on the overall construction budget and finance provision.

Although supply chain has now improved and materials inflation has since diminished, currently at around 0.5% per month (ONS new housebuilding in March), the focus has shifted to the housing market and the exit position on schemes for many developers. The cost of living crisis, combined with increased mortgage costs has undoubtedly negatively impacted house pricing and activity.

How has the housing market been impacted?

Mortgage rates are now at around the level of 6% for a 5-year fixed rate deal which is a far cry from the ultra low rates of 2-3% seen in recent history. Extensions to mortgage long stops dates typically at 3 months have become critical to cash flow for many developers. Marketing campaigns in some cases have been advanced and intensified. Nevertheless, some sectors for certain products such as downsizers, who may have already sold their homes are still evident in the market and with limited supply of appropriate quality housing stock. We have observed healthy and sustained activity in this sector.

The reduction of overall affordability for consumers has impacted national house price growth, with June monthly data varying but broadly flat: Halifax 0.0%, Nationwide 0.1%. Zoopla has reported a Q2 increase of +1.2% but most forecasts for 2023 indicate an annual fall in house prices of between 5-10% for 2023. The forecast for 2024 and 2025 vary but subdued prices in 2024 are likely with Savills predicting a recovery due to falling inflation in 2025/26.

Private housing supply

The cumulative effect of undersupply of housing provisions may continue to provide some resistance to the effect of these headwinds. The Government has undertaken a working group on housing supply which shows that the Government target of 300,000 per annum is not currently being met (c. 233,000 best estimates), indeed a recent study by the National Housing Federation/Crisis in conjunction with Heriot Watt University has indicated that this figure may need to be at 340,000 homes per year in order to just to meet current demand.

Furthermore, the Home Builders Federation (HBF) has warned of a reduced supply of housing from 233k to 120k in 2023, which could have the effect of supporting prices but could also further exacerbate the already current tight supply. Accordingly, Glenigan’s Economic Unit forecasts the number of private housing starts to be around 18% down for 2023 but they also indicate a rebound in 2024 (+12%) and 2025 (+3%), as a strengthening UK economy lifts consumer and business confidence again.

Growth in the Build to Rent market

In the last quarter, we have seen the reduction in affordability and ability to purchase housing now morphing into increased demand in the private rented sector, which perversely shows a rental growth of 3.3% nationally in June 2023. This could mean the build to rent (BTR) sector being more interesting, with alternatives to direct sales becoming an attractive proposition to developers at the exit. Investors are also focusing on residential units with a minimum EPC rating of C in lieu of the Government target for newly rented properties by 2025. A recent study by Rightmove has shown that investors are already making this transition to units with EPC C or greater. A further opportunity in this sector for developers perhaps.

The Renters (Reform) Bill was submitted to parliament on the 17th of May which aims to amend the laws in the Housing Act 1988 surrounding, among other clauses, a change to no fault evictions (Section 21.). This may add a further level of complexity to the private rented sector and should be followed closely over the coming weeks and months.

Important concerns for safety on site

Finally, a note of safety. The use of asbestos, particularly in the 1960s-80s construction is well documented and a recent worthy awareness campaign launched by the HSE “Asbestos and You” aims to highlight that this is not a forgotten issue. There are still up to 5,000 deaths per year from mesothelioma makes this very much a live issue on construction sites. Conversion of older buildings for example from office/hospital/school /care home to residential means that sufficient budget and expertise needs to be adequately costed in for such schemes.

In summary

In conclusion, the second quarter of 2023 brought its challenges. Inflation and interest rate hikes impacted the housing market, while housing supply and safety concerns persisted. The build-to-rent sector emerged as an alternative, and meeting energy efficiency targets became crucial. Looking ahead to Q3, staying adaptable and seizing opportunities will be key in navigating the changing landscape.

If you are ready to explore potential funding solutions, do not hesitate to connect with our team of property experts today.