Residential Viability Update - July 2023

A scheme’s viability is fundamentally affected by many different factors.

 

So, what is happening in the market at the moment, and how might that impact viability assessments – and therefore affordable housing contributions – more broadly.

House Prices

Nationwide’s House Price Index has fallen off a cliff in 2023. From 10-14% in early 2022, annual growth has now dropped to -2-4% in Q2 2023. All regions are showing negative growth or contraction in pricing. Savills' is predicting a 10% contraction in 2023 overall.

 

The difficulty in viability assessments is the requirement to value as per the available transactional and market data. Appropriate adjustments must be made to advertised pricing with consideration given the current market environment and buyer negotiating power. Historical transaction data in the previous year must be treated cautiously as representing a very different seller’s market environment.

Transactions

Estate agents are particularly gloomy about the market in the near future. Existing deals are falling through as mortgage offers expire, and fewer people are looking to move. RICS reported a -45 net balance of new buyer enquiries in July 2023. Savills report that transactions are down 23% compared with the 2017-19 average.

Finance and Mortgage Rates

A lot of this sentiment is driven by the increased cost of servicing debt. A typical first time buyer looking to buy a £300,000 house with a 10% deposit is now looking at an average 5.8-7% 2 year fix, of 5-6.4% for a 5 year fix. This disparity suggests banks expect short term high interest rates to be sustained or increased, with longer-term reductions.

 

The Bank of England has raised the base rate from 0.1% in Q4 2021 to 5% in Q2 2023. Industry experts expect rates to go higher still in the Banks attempt to combat inflation, with broad predictions of 6.5-7%.

This has broad implications not only for residential buyer demand, as fewer can afford to service mortgages, but also rent-to-buy debt to income ratio, with a range of potential impacts including rent rises, investors withdrawing from the market and increased supply. Broadly we expect this to further drive down house prices into 2024-2025 as fixed deals expire and we enter a period of oversupply and under demand.

 

Beyond this, financing for sites is becoming considerably more difficult, particularly for smaller developers on higher risk sites.Traditional lenders are more risk averse while non-traditional lenders seek above-market returns on investment. As such we advise the historically accepted viability finance assumptions of 6-7% are no longer relevant, and must be adjusted upwards based on the base rate increases which have occurred.

Build Costs

General inflation currently sits at 8.7% (ONS). However, build costs are a more positive picture. Following a period of intense growth during 2022/23 of c10% (largely driven by materials inflation of c.25%), BCIS TPI has fallen back into more normal sub-5% ranges. While this spike in materials costs appears to be falling back however, labour cost increases are expected into 2024-25 in response to heightened general inflation, with 5-10% increases on labour costs.

 

However, the full impact of new building regulations requirements has yet to be felt in the BCIS index. We therefore anticipate enhanced energy and fire safety regs in particular will have an inflationary impact on build costs through 2024 of c.6% based on the assumptions in area-wide viability studies.

 

Given this we would advise adopting a Mean or Upper Quartile generic assumption in viability assessments.

Other Costs

Other costs of further planning regulation will begin to be fully realised through 2023-24, including biodiversity credits and phosphate offsetting. These costs are difficult to quantify at the current time due to their formative nature; however government assessments have estimated between 0.1-3% of base build cost for biodiversity uplift to be achieved onsite. Offsite credits will be considerably more costly.

Other Viability Inputs

Other standard viability inputs include contingency and fees.

 

We consider that percentage based fees are likely to remain constant at a rate of 8-12% depending on site size and complexity.

 

However contingencies have traditionally been assumed at 3-5%. In the current inflationary environment of 8-10% general inflation it would appear prudent to adopt a contingency in excess of this, in the region of 7.5%.

Timing

Traditionally, viability assessments have assumed a 3-6 month lead in period to development, with construction timing assessed on a case by case basis.

 

Given the current delays seen across the board in the planning system, including increased lead times for the Inspectorate, along with the current market environment, we expect many projects to be delayed considerably prior to start. On this basis we are more cautiously adopting longer lead-in times and longer sales periods to account for this risk.

Conclusion: Costs Up, Values Down

Overall, the UK is entering a new economic cycle. We expect a considerable residential market adjustment over the coming 12 months, while costs and delays continue to grow. All of the above points to an increased number of viability challenges as more previously marginal sites tip into unviability, and previously viable sites become marginal.

 

If you would like to discuss your site’s viability needs, please give us a call today.

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