The real estate market is a dynamic landscape, influenced by various external factors that can significantly impact property development companies and their financial backers. Several market conditions have created challenges for lenders in recent years, particularly when dealing with incomplete development sites. Let’s explore these challenges and delve into potential solutions available to lenders when an incomplete development becomes distressed.

What external factors are affecting lenders in real estate?

• Interest rates: the rise in UK interest rates has become a critical concern for lenders. Borrowing costs have increased, rendering some development schemes financially unviable. Lenders must carefully assess the impact of interest rate fluctuations on their loan portfolios.
• Higher mortgage rates: compared to the past 15 years, mortgage rates are now higher. This has led potential buyers, especially in the residential sector, to reconsider their interest in properties. Cooling demand affects sales prices and elongates sales periods, resulting in increased holding costs for developers.
• Escalating costs: energy, materials, and labour prices have surged since the onset of the pandemic. And, although there has been some correction, labour costs remain notably higher than historical levels. Developers may face unexpected budgetary constraints due to these cost escalations.
• Contractor insolvencies: the risk of main contractors or key sub-contractors facing insolvency poses a significant threat to development projects. When a contractor fails, it disrupts the construction process and can negatively impact the overall project timeline and quality. As demonstrated in the chart below, insolvencies of construction companies in England and Wales rose by 38.3% from 3,170 in the year to 31 January 2020 (immediately prior to the pandemic) to 4,383 in the year to 31 January 2024.

What solutions should lenders explore?

Lenders can consider various solutions to mitigate risks. An initial assessment of a distressed part-built development is the recommended starting point for lenders. This involves understanding the costs to complete the build, an assessment of the current site value, an assessment of future gross development value, and the costs of capital (or holding costs).

From there, the following actions could be taken. It is important for lenders to seek advice from a specialist accountant to ensure they take the most suitable treatment.

• Refinance: lenders can explore refinancing options by working closely with developers and specialist accountants. Alternative finance sources can provide an exit strategy for lenders.
• Completion under close monitoring: reaching practical completion (PC) often yields the best outcome. PC unlocks warranties of suppliers and enhances the realisable property value. Close monitoring by the lender’s quantity surveyor and specialist accountant is often beneficial to ensure the project is completed.
• Sale of the development in its current form: if an immediate sale offers the best net return, collaboratively working with a developer, outside of any formal enforcement process, may be the most appropriate strategy. Structured sale processes overseen by external parties add focus and help secure essential documentation.
• Enforcement to sell or complete the development: in cases where a developer refuses or cannot cooperate, lenders may appoint an LPA (Law of Property Act) receiver or an administrator. These advisers work with lenders to progress an optimal strategy for realising the asset.

Navigating incomplete development sites requires lenders to be proactive, adaptable, and well-informed. By understanding market challenges and exploring tailored solutions, lenders can mitigate risks and contribute to successful property development projects.

Remember, seeking advice from specialist accountants is crucial throughout this process. Lenders play a vital role in shaping the real estate landscape, and strategic decisions can lead to positive outcomes for all stakeholders involved.

If you would like further information on what would be the best solution for you, please contact Lee Lockwood or Gordon Thomson.