The prime central London residential market is experiencing turbulence. Price growth is slowing and developers are feeling the heat as they look to shield their profits.
Over the past few months we have seen the capital’s political and economic landscape shift beneath our feet, as we contemplate whether we are “in” or “out”. We have had to deal with a culmination of fiscal policy changes, including a significant increase in stamp duty, endure historic low interest rates and look further afield to the Chinese slowdown and volatile oil prices.
The result has been uncertainty that has permeated the PCL market and has put the brakes on what has been phenomenal sustained growth over the past few years.
Clearly, the most significant recent change to the market is the inauguration of our new mayor. The extent to which Sadiq Khan’s manifesto pledges will be realised has yet to be seen, as he turns his attention to the London housing market. For PCL, the likely consequence of Khan taking the reins as commander-in-chief for London’s housing and planning policy is that it will be more difficult to push through high-end developments than with his predecessor.
But, while Khan’s election has some influence on the PCL market, its issues are more deep-rooted in broader macroeconomic pressures and questions, with Savills reporting just 2.6% market growth for the year to March 2016 – a figure dwarfed by the 35% growth achieved by the sector since 2009.
This stagnation and uncertainty is being felt most keenly by developers. While the resale market, still hit by outside pressures, pushes on, albeit at a slower rate, developers who have raced to capitalise on London’s hot prime residential market, based on assumptions made about market conditions over two years ago, have inadvertently driven a development glut.
The combination of this jump in luxury new-build developments and difficult conditions has caused price growth to dip. Consequently, the burgeoning PCL market, which is arguably largely reliant on wealthy foreign investors, is not seen as the safety deposit box or quick buck it once was.
As an added pressure, high-interest development finance, typically around 10-15%, is a burden as heightened construction costs, delays and falling prices mean that developers are looking down the barrel of a potential profit shock.
For developers, the problem with finance lies in the fact that most loans on PCL schemes originate from the alternative debt space and therefore have many rigid strings attached that can seem hard to cut.
Often these loans are priced in accordance with investor target returns and are time-critical, as lenders price their product based on exiting after a fixed time period. In the current climate, the more nervous lenders are analysing their positions very carefully and stepping in where necessary. In other cases, delays to practical completion can cause equally problematic issues. Lenders, of course, do give options for extension, but at a cost that is often unappealing.
Luckily, we work in a dynamic market that can respond to these external pressures and weather uncertainty as London is regarded as a premier world city with the facilities to match. The capital will continue to be a draw for the super-wealthy and the market will recover in the medium to long term. For developers and investors, it is therefore a question of how to ride out this temporary instability and to focus greater energy on protecting capital and cost to ensure a bottom-line profit.
The solution for developers with moderate LTVs delivering quality products is to offer a new type of finance known as practical-completion financing. This enables a developer to fix its debt at a potentially lower rate to protect and drive profit, giving them the option to postpone the sale of their properties – safely buying time while waiting for the market to regain confidence.
The storm clouds will clear and the PCL market will get back on track, but, until then, it is vital that developers understand the market and their options. It is important to remember that the PCL market is not a race – those who bide their time and bolster their financial position will ultimately come out on top.
Wayne Coleman is director at W Coleman & Co
