Market overview
“A challenging market, low savings rates, poor returns” - our IFA partners tell us just how difficult it can be to source good income for their clients.
Background to the market opportunity
Successful origination and project management of development lending facilities requires a specialist skill set and a rigorous approach to the selection, assessment and analysis of development funding proposals. Carefully selected and managed development lending is a secure, profitable and low risk investment. The BLSI Fund provides access for your clients to this investment class which has previously been the preserve of private banks, hedge funds and large institutional investors.
The right counterparty: probably the most important part of the selection process is to choose developer partners who are highly experienced and know their market sub-sector intimately. With credit rationed by the mainstream and overseas banks, particularly the Irish & Icelandic banks having withdrawn, the market opportunity to partner with the best developers is excellent. All our developer clients are experienced many we have known and funded for up to 20 years.
The Directors have therefore identified an excellent opportunity for the Fund to capitalise on the space in the funding market created by the withdrawal or reduced activity of previous incumbents in this market sector. Rates of return on loans are more attractive and it is possible to select the best quality developer counterparties to work with. The Directors will create a carefully risk-managed portfolio of development loans and will therefore offer investors exposure to, (i) High levels of return, (ii) Returns secured by real estate assets; and (iii) Moderate liquidity as loans are written for 24 months or less.
Furthermore, in the view of the Directors, this market sector will provide a ripe opportunity for investors for several years; the mainstream banks will not re-occupy this territory.
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Estimate of size of the development finance sector
There is little statistical data to verify the precise size of the development funding market. The Directors have assessed the total size of the market to be c£30bn having regard to the average house value and the average number of housing starts in any one year. The size of the funding market has fallen significantly in the past 2-3 years as experienced developers have destocked and the banks have withdrawn or reduced support to this sector. Business Lending Group has estimated that the withdrawal of the Irish and Icelandic banks has removed between £6bn and £8bn and that a further £8bn to £12bn capacity either has or will be removed as RBS and Lloyds Banking Group re-balance their lending books.
The house development finance sector is therefore estimated to be between £14bn to £16bn, approximately half of its peak value 2007 but has now stabilised and is expected to grow modestly over the coming years. back to top
New homes market
Historically, the UK residential housing market constructed circa 160,000 units per annum. However the previous government’s targets required annual housing starts to increase to 240,000 units per annum to meet with anticipated demand. As a result of the credit crisis actual housing starts have been at or below 100,000 per annum for the past 3 years. Commentators are now suggesting there is a significant latent demand and need for new housing at every level of the market.
Whilst the attractiveness and profitability of the development funding is not directly correlated to the housing market (development funding can be profitable even in a market where house values are falling), a major shock in the housing market does effect the sales liquidity of the developers’ completed product and makes profitability measured by Internal Rate of Return more difficult to sustain. We have therefore sought to analyse in brief the UK housing market and its likely future movements. back to top
House price forecasts
Forecasting UK House Prices is a notoriously difficult art form; few commentators foresaw the end of the decade long boom in late 2007 or the severity of the crash in 2008. Equally the doomsayers projecting years of contracting values from the second half of 2008 were red-faced when the market moved forward again in 2009.
The market is currently pushed and pulled by conflicting economic data and buyer/seller sentiment. On the positive, the economy is growing albeit at below trend rates. Interest rates are low and appear likely to stay low; affordability for anybody with a mortgage is good. On the downside fiscal tightening has put pressure on public sector jobs.
Furthermore the “market” as it is often referred to in the popular press is not one single market but layers of local and regional sub-markets. Indeed regional features are likely to be one of the dominant features of the UK-wide market going forward, as areas with a higher percentage of public sector employees are generally forecast to be facing a more uncertain market than those areas less dependent on the public purse.
Looking forward, the market is likely to continue to be pushed and pulled in different directions, the consensus view of most forecasters is that 2011 will be a stable but un-spectacular year with prices moving up or down by one or two percentage points. Most commentators view 2012 and beyond more positively with often showing strong growth during this time. Furthermore commentators appear to be fairly uniform in their long term analysis of housing stock, the UK simply isn’t building enough new homes. And this will continue to apply inflationary pressure to house prices. back to top
How house price movements will affect the performance of the fund
Whilst development funding is clearly affected by sentiment and movement in the housing market it is not directly correlated, i.e. a 1-3% fall in housing values does not automatically result in a 1-3% fall in the value of the Fund investments; indeed development funding can be robust and profitable even in a moderately falling market.
Typically the fund will require developments to show a profit on costs of in excess of 25% and a profit on projected sales values of over 20%, although each transaction is analysed individually and the Asset Advisor will recommend transactions based on the risk/reward of each deal. The result of this is that values can fall markedly before the development scheme profitability is fully eroded.
Significantly, however, whilst the development funding sector is influenced by conditions in the property market generally, it is not directly correlated with the performance of the property market. This means that a number of loss mitigating features can be put in place with development funding that may not be available in direct real estate investment. Further, development finance loans can deliver high quality returns even if house prices are diminishing. back to top
Take a look at the types of projects we fund:
View BLG’s typical case studies > more back to top
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The investments described are unregulated collective investment schemes as defined by the FSMA. The Schemes have not been authorised or otherwise approved by the FSA and, as unregulated collective investment schemes, cannot be marketed in the UK to the general public.
The Information Memorandums give information relating to the fund, and should be read and understood prior to any investment being made.