A question of scale With the end of easy credit, there is increasing doubt over the viability of a business model that saw large-scale development during the boom years. So will the future see smaller schemes… and smaller risks? Graham Norwood reports
The housing slowdown has shaken residential development so fundamentally that experts now question the very business model that has existed for more than a decade. What is less clear, however, is what will take its place.
Until 2007, developers pulled in institutional investors despite many projects involving multi-year and multi-phase schedules. The scale of development boomed, relying on high volumes of off-plan sales to consortia which secured vast amounts of easy credit.
As a result, says Savills, 51% of units now in London’s development pipeline – the ones still on course despite the slowdown – are in schemes of 500-plus homes.
But is that scale of development supportable in future? Probably not, given this triple whammy:
In addition, planning is at a near standstill throughout the UK because existing consents have become outdated by the credit crisis, and many councils are stalling ahead of the imminent general election.
“Many planning permissions won in the two or three years preceding 2008 are unworkable because of unaffordable s106 obligations or because the mix and design of units no longer match market requirements,” explains Ian Tant of planning consultancy Barton Willmore.
He adds: “In many places, councils are waiting to see whether a Tory victory materialises – and what the Conservatives will actually do with the planning system – before committing to new housing allocations. At best, this will delay allocations and interrupt supply.”
So what happens now?
Talk to any new-build developer or land agent and you hear the same story: only those sites valued below £5m are selling to builders in any volume, because they simply cannot borrow enough funds to purchase larger sites.
The temptation, then, is to assume the industry must retreat to smaller schemes with commensurately smaller risks. Most developers accept that would be the ideal for some years to come, but getting there is not as easy as it sounds.
Stephen Stone, chief executive of Crest Nicholson, insists that a few large developments cannot be replaced by many smaller schemes unless the planning regime changes.
He says: “Smaller developments and more outlets sound logical but this would mean more land acquisition delays and multiple planning consents running in parallel. They already take years. So perhaps the public sector should do all that in future, then hand them over to the developer at a post-planning stage.”
James Thomas, head of Jones Lang LaSalle’s residential development and investment team, says: “Joint ventures and subject-to-planning transactions with deferred payments, potentially linked to exit sales revenue, will reduce the risk. Off-plan sales can help the cash flow but, in a rising market, off-plan sales are less attractive because higher revenue can be captured later in the development process.”
Not only will funding models change but so, too, will the balance between the numbers of blocks and mix of houses and apartments in schemes.
“Overall block size will be reduced in order to reduce the capital tied up in a particular block that ‘once started, must be finished’. Future developments may thus comprise greater numbers of smaller blocks to reduce risk,” says Crispin Topping, development director at BNP Paribas Real Estate.
He says that larger flats traditionally produce lower per square foot sales values and have, therefore, been marginalised during the 2000-07 bull market. “Lower land values and a calmer market will, hopefully, allow developers to build and sell a better range of units and not just small, sub-800 sq ft one- and two-bed flats,” says Topping.
Barratt Homes says that its business model is already changing and it has reconfigured its build mix. In the year to June, 46% of its completions were houses and 54% flats, where two years earlier around two-thirds of all new units were flats. It anticipates that the balance will move to 60:40 in favour of houses within two years – except in London, where almost 100% of completions will still be apartments.
Another possibility is the emergence as an alternative funding model called build-to-let. This is when institutions – typically pension funds – invest in a private rental sector of branded accommodation, retaining involvement as the properties are let. They rely more on long-term rental income to justify the build cost, rather than selling at completion to an institution or multiple buy-to-let landlords.
The British Property Federation and many other players support build-to-let but, again, those on the ground demand a helping hand from the public sector.
“The idea’s got potential but we’d need the planning system to become more flexible,” says Crest Nicholson’s Stone. “Institutions investing in build-to-let may not want any social housing as part of their schemes, for example. Would planning authorities accept that? Even if they did, the idea would take at least two years to get off the ground.”
The strong industry consensus is, therefore, that the old business model is dead. There is an equally widely held view that the public sector should do more to help builders through greater land acquisition or more relaxed planning, or both.
Ironically, this new public-private business model is emerging just as a party urging more localism and less interventionism seems poised to form the next government. Times are changing for residential development – but what will be the end result?
Planning shake-up on the cards
It is not just the developers’ business model that is changing. So is the planning regime that, since 1997, has been driven by centrally devised targets for new homes.
A letter sent in August to chairmen of Conservative local authority planning committees by shadow communities secretary Caroline Spelman shows how residential planning may change should the Tories win the next election.
It says unequivocally that a Conservative government “will abolish the bureaucratic and undemocratic tier of regional planning”, including Regional Spatial Strategies and regional planning bodies. It also promises that “local authorities will be able to review their Local Development Frameworks to undo unwanted planning policies which the Regional Spatial Strategies had imposed upon them”.
Many Conservatives believe that New Labour and housebuilders were unacceptably close to each other – which may be why developers get little sympathy from Spelman. “We will not pay a penny of compensation to speculative developers as a consequence of changes in planning policy,” she pledges.
She also urges existing Tory councils to delay major planning decisions until after the spring election. She says: “We would advise councils not to rush ahead with implementing the controversial elements of Regional Spatial Strategies, expending time and taxpayers’ money that may be wasted.”
