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CURRENT CHALLENGES TO PROFITABILITY IN PROPERTY DEVELOPMENT Ricky Prota November 29, 2023

CURRENT CHALLENGES TO PROFITABILITY IN PROPERTY DEVELOPMENT

property development

Market fluctuations, regulatory changes, and unexpected expenses all pose significant challenges to developers. Thus, profit offers a financial buffer, safeguarding against potential setbacks, and enabling developers to absorb unexpected costs and adapt to changing market dynamics.

A profitable venture not only instils confidence but also ensures the viability of the development, making it an attractive proposition for financial backing.

Beyond risk mitigation and financing, profitability acts as a powerful incentive for innovation and quality within private development. Profitability rewards developers who deliver value, encouraging them to create projects that enhance urban aesthetics, functionality, and environmental sustainability.

However, inflation, policy changes and other factors are affecting profitability for both private developers and Registered Providers (RPs) at-present. This article will review several key challenges the UK market is facing.

Then & Now

When SDS started trading, life in the housing development world was very straightforward. You found a scheme, applied for grant and built it.

It was very unsophisticated: grant allocations were no guarantee of receiving the cash; funders were still trying to understand the risks; there was no policy of linking rents to public subsidy; private developers tried their best to offload their affordable housing obligations and generally associations and developers failed to understand each other.

A key characteristic of today’s development scene is that associations are no longer the sole providers of social housing. Even most private developers have grasped the economics behind it.

Associations offer a mix of tenures: affordable and social rent, shared ownership, private rent and private sales, this last activity helping in cross-subsidising schemes from the profit they generate.

Housing associations have become more like private developers, albeit with different objectives. The reality of associations making sufficient surpluses, or profit, to subsidise social housing, without using public subsidy, becomes a possibility.

Profit is absolutely essential to guard against the high risk associated with private development. But will associations want to go down that path? Is that what they set themselves up to be? 

At the very least, the profit has to be secured before it can be used for other purposes.

Too often, profit is identified and allocated before the cash is realised. Private development has the capacity, when it goes wrong, to cause serious problems for the association’s social housing business. Funders are likely to be very wary of lending on this basis.

Unfortunately, many organisations fail to appreciate either the risk of speculative development, or the business processes needed. Confidence in the housing market has been fluctuating since the start of the year, the most recent setback increasing mortgage rates.

Current Challenges

There is a common belief that public subsidy will disappear. This is hard to accept, because if it were possible to develop without grant then we would have no need for a social housing sector.

The debate has to be about how that subsidy is provided – capital and/or revenue, and who should provide it.

The demand for housing of all tenures is also fuelled by demographic changes. There are real problems caused by an ageing population and with young people being forced to live with their parents longer than either would prefer. We need more homes suitable for single persons and for the elderly. Much of what was previously developed for the elderly is today sub-standard. However, with the economy in its current state, is it possible to meet these requirements?

Inflation

The current economic challenges have affected the housing market, particularly in regard to affordable housing in London. High inflation in the construction sector combined with high interest rates when borrowing from the Public Works Loan Board have significantly reduced the viability of projects.

Rent Increases

Registered Providers (RPs) face a dilemma due to high inflation: should they increase rents according to the permitted levels stated in the tenants’ leases, putting more pressure on tenants that are already struggling? Or do they avoid doing so and absorb the associated costs themselves? With the maintenance costs involved in repairing some of the older social housing units, many RPs may find themselves in a difficult situation here.

In addition, the loss of tenants that cannot afford to pay increased rents will mean that some landlords may need to sell the property – and in the current market conditions, that’s far from ideal. 

Policy Changes

The 7% cap on social rent being introduced this year is forecast to reduce investible income for local authority landlords. For example, in London, this income is forecast to reduce by almost £600 million over the next five years and £8 billion over the next 40 years.

Issues in the Construction Industry

The workforce in the construction industry declining and wages are lower than in other industries. Productivity levels are also below average; with low output and late delivery, profits have been impacted. Increasing costs and supply chain struggles puts a further strain on developers.  

Conclusion

Profitability plays a crucial role in safeguarding property developers, both in the private and social housing sectors, against the inherent risks they face.

However, the current landscape presents numerous challenges to profitability in the industry. Factors such as inflation, rent caps, policy changes, and issues within the construction industry have a significant impact on the viability and profitability of projects. These challenges require careful consideration and strategic planning to ensure long-term sustainability.

The demand for housing persists – particularly affordable housing. As such, it is essential to address these challenges while finding sustainable solutions to meet the needs of diverse communities.

SDS provides market leading software and consultancy services, helping you maximise the development, sale and management of affordable and commercial homes. For more information about how we can assist, contact us today.

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