Risk management in post-Brexit property development: what’s the Qandor view?

Both the government and its opposition are divided over the best way to proceed with Brexit, and whichever stance is ultimately agreed on is bound to find more difficulties down the road in the negotiations with Brussels.

In light of these uncertain times, it’s important for property businesses to take steps to minimise the risks associated with Brexit. Here, we’ll take a closer look at how you can try to manage and minimise these risks.

Economic uncertainty

When the UK chose to withdraw from the European Union in a bitterly contested vote that saw the Leave camp prevail by 52% to 48%, many feared a collapse of the British economy. Despite some initial shockwaves that saw the pound fall in value, construction shares falter in the stock market, and the property industry, particularly in the commercial sector, skip a beat or two, the economy proved more resilient than expected. At the same time, though, it quickly became apparent that virtually every industry in the UK was rather more deeply enmeshed with the EU than had perhaps been anticipated — so leaving the Union required a solution that would safeguard sectors as diverse as cattle breeding and video games.

Under current proposals, the UK would leave both the European single market and the customs union, but would also adopt a temporary arrangement that essentially mirrors the existing customs union until a definitive solution is negotiated with the EU — ideally, a comprehensive deal covering trade and financial services. However, not everyone within the government supports this position, and even the EU itself has voiced numerous doubts over whether these plans are workable.

This uncertainty is obviously a stumbling block for property developers, not only because it means that investors may be tempted to sit on the fence until the future becomes clearer, but also because decisions must be taken now over projects that may be ready in ten or 15 years’ time — with little way of knowing whether there will be any demand for these units.

At a time when changes to stamp duty, buy-to-let mortgage relief, business rates, capital gains tax, and non-domiciled resident legislation had already unsettled the market, particularly for higher-value and secondary residential properties, Brexit has added new qualms to existing misgivings. The Office for National Statistics, for instance, records an 11.8% decrease in transactions between March 2017 and March 2018, whilst the Bank of England reveals a reduction in approved mortgages between last February and last March. In particular, London, where prices are higher and the market is global, has borne the brunt of the Brexit-fuelled trepidation, with a survey done by the Royal Institute of Chartered Surveyors (RICS) revealing subdued sentiment among industry professionals, leading to expectations of a further drop in prices.

The risks of Brexit

Looking ahead, there’s no doubt that, if the UK crashes out of the EU without a suitable deal, construction and renovation costs could rise. This is not just because trade barriers would make materials more expensive but, vitally, but also because finding labour, which is already challenging, could prove much harder and pricier. Research by the Construction Industry Training Board has shown that one in three workers comes from abroad — a figure that rises to one in two in London. This means that ending free movement of labour from the EU, combined with the government’s drive to reduce net migration, would inevitably put a strain on the entire sector. In the short-term, the introduction of border controls could also delay the delivery of development projects, as there is a concrete risk of materials getting stuck until customs clearing procedures are well honed.

Much also hinges on inflation and interest rates. After the pound dropped in value in the second half of 2016, consumer prices rose rapidly. Since then, sterling has bounced back and inflation has somewhat slowed down. But if sterling suffers another significant loss in value after March 2019, and this, coupled with trade barriers, sends consumer prices spiralling upwards, then the Bank of England is likely to take action. It’s hard to predict how high Threadneedle Street would be prepared to go, and it’s likely that any change would be gradual, but a sizeable rise in the cost of borrowing would impact the industry twice — both by making it more expensive to obtain capital to fund development projects and by making it harder for end buyers to finance their property purchase. Galloping inflation would also make your cost base higher, potentially eroding margins. As an example, a study by Cambridge Econometrics for London’s Mayor, Sadiq Khan, estimated that the economic output of the construction industry (measured by gross value added) could shrink by 3.5% to 8.2% by 2030, depending on different Brexit scenarios.

Property: a resilient sector

Yet, the fundamentals of the UK economy continue to look solid and the past few months have seen encouraging signs, particularly in some regional markets, where the appetite for property outweighs the unease caused by political instability. In the year running up to March 2018, prices across the country grew by an average of 4.2%, despite dropping in London, with areas such as Scotland and the East of England seeing rises of 6.7% and 5.8% respectively.

What’s more, the UK remains an attractive destination for investors: the relative weakness of the pound fuelled the flow of inbound capital, and the government has shown some willingness to support the industry in years to come, not least by committing to deliver 300,000 new homes a year by the mid-2020s. Short of a major economic catastrophe, all this should stave off the risk of a market crash. In fact, Deloitte’s latest Real Estate Crane Survey shows buoyant sentiment among developers with “record levels of construction activity” in cities such as Birmingham and Leeds.

How to manage your exposure

With so many details still up for discussion ahead of the official Brexit date of March 29, 2019, it’s important for property businesses to adopt robust risk management strategies in order to protect themselves against Brexit’s uncertainties. The first step is to carry out a thorough risk assessment. Questions to ask yourself range from how much you rely on EU labour and supplies to how exposed your business is, to currency and market fluctuations.

Armed with this information, you can then draw up risk mitigation plans. For example, if you currently source many of your materials from the EU, you may want to look for alternative suppliers within the UK. If you’re reliant on immigrant labour, now is the time to consider other ways to secure a skilled workforce, including putting into place apprenticeships and training programmes. Or you can invest in technology — from building information modelling to field-productivity programmes — to help make your crews more effective, or reduce costs and development times. Likewise, safety, which is always an issue for developers, but particularly so when you have to employ less experienced labour, can be enhanced with monitoring tools.

Ultimately, you should also make sure your product is as appealing as possible to investors. In volatile times, buyers tend to fly to safety — so offering good-quality, correctly priced units in sought-after areas can help. Negotiating contract clauses to protect yourself in case of Brexit-induced delays in project delivery is highly advisable. And remember that, so long as your balance sheet is healthy, even a weak market can present opportunities — if only because it allows you to save on the cost of land or properties ripe for development.

At Qandor, we provide a friendly, driven environment for professionals who want to learn and share knowledge of the industry, and of how to progress through it with integrity — whether this is in property finance, or risk management. If you’re interested, head over to our Advice page for more property insights.