There are very few sectors of the UK economy sheltered from the impact of repeated interest hikes, and real estate is not one of them. Over the past 12 months, the market has moved from a zero-rate environment to one where the cost of capital has been gradually rising, affecting real estate financing. 

Paul Oberschnieder

Paul Oberschnieder

To add to the residential supply squeeze, last year’s decision from the UK government to remove the 300,000-new-homes-a-year target has undermined incentives for local authorities to accelerate planning decisions.

Now, any hope of overcoming the housing crisis seems to have evaporated. Despite a decade of low cost of capital, we failed to deliver the homes that the country needed, with planning being the main obstacle.

The most obvious challenges for SMEs in this new inflationary context are persistently higher build costs, limited access to project finance as commercial banks retreat from the £1m to £10m development space and a slow planning system. While construction cost inflation could be offset by higher rents, no access to loans to deliver projects can bring SME development to a halt.

The tailwinds lie in the establishment of alternative lending platforms post-2008, which are now ready to offer institutional investment.

Alternative lenders are filtering through more loan applications since mainstream finance sources have retrenched. They are also choosing those applications where developers are experienced in handling costs and managing contingencies.

The criteria for a successful project is changing, however. According to one lender, 15% profitability on a residential scheme does not stack up anymore, given the political economic uncertainty. In order to lend against a project, it needs at least 25% profitability and an experienced developer to justify the higher risks.

What lenders need, to continue supporting SMEs delivering much-needed homes, is certainty around policy.

Alternative lenders are filtering through more loan applications since mainstream finance sources have retrenched.

Even with uncertain and gloomy predictions on asset values, there is optimism about the strong fundamentals of the residential market in the UK. Lenders are confident that the structural lack of housing supply will keep the sector attractive in the short term.

Developers agree. But the cloud over their ability to deliver is the UK’s overly complicated and time-consuming planning system, stalling the pace at which housing projects can get off the ground.

But will this chronic housing shortage be enough to entice capital?

The capital raising environment has been one of the most difficult in 2022, affecting liquidity and reducing what fund managers can allocate to private markets, further limiting sources of finance.

And while SME developers, which cannot tick the loan boxes of a commercial bank, are good news for alternative lenders, do they have the resources for proper due diligence?

Integrating tech into the process is a cost-effective and secure way of processing more applications. Tech can help accelerate the pace of loan applications evaluations but there will always be a need for human oversight and relationships. Tech has a great role to play but it can’t lead the decision.

Next year will perhaps dispel some of the tensions between buyers and sellers and bring more clarity for the residential market. In the meantime, the government must stick to housing targets and reform the planning process. Lenders and SMEs can get creative in 2023, but planning must be able to keep up.

Paul Oberschnieder is founder and chief executive at Hilltop Credit Partners