By David Norman, Founder Director at Davon Investments.

At last year's MIPIM, residential developers and investors from the UK were subdued. Falling interest rates at the start of the year had sparked hopes of a construction boom, but in Cannes in March 2024, that optimism had faded, as the market faced further uncertainty due to the general election and subsequent Budget.

A year on, and MIPIM delegates returning to the UK are reporting a brighter outlook after enduring torrential rain in Cannes.

That may be the case for the wider real estate sector but housebuilders, especially small and medium-sized developers, are still grappling with multiple challenges.

As a provider of mezzanine finance provider to this market, we know how this sector is still battling cost overruns, high prices for materials, long lead times and expensive labour in a market that might be described at best as mixed.

Potential investors in SME resi developments remain cautious. That goes for the developers themselves, equity investors and banks as well as other first-tier lenders and second-tier lenders such as ourselves.

And with higher interest rates on savings on offer, many are content to leave their cash in safer places, rather than risk it on speculative ventures.

Market confidence has been shadowed by doubts about the government’s ability to deliver growth.

January brought some relief as UK inflation unexpectedly slowed to 2.5%, paving the way for a Bank of England rate cut that should have eased pressure on the Chancellor but instead it came with a feeble growth forecast for the year. The economy now seems to be flatlining. At least, mortgage rates will come down.

House Prices

While agents report rising house prices, the increases are uneven, driven by gains in the north of England and Scotland. Mortgage rates are still relatively high, and the market is sluggish. Smaller residential developers are seeing a 10-15% drop in pricing. Many developers are now adjusting their financial models to account for longer sales cycles and reduced profit margins. Mezzanine finance is increasingly being used to bridge funding gaps as mainstream lenders tighten their criteria.

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Mid-Market Challenges

The mid-market faces significant challenges, particularly for families dealing with stamp duty, private education costs and the overall cost of living. These pressures are limiting the ability of second-steppers to move up the property ladder, leading to reduced demand for mid-range homes. With fewer buyers able to afford upgrades, developers targeting this segment are experiencing slower sales and rising holding costs.

First-Time Buyers

Without the Help to Buy scheme, first-time buyers also struggle with higher stamp duty, now that the discount on new homes has ended. Despite calls to embrace renting, the UK remains culturally attached to home ownership. The deposit requirements and mortgage affordability tests remain stringent, making it difficult for many to secure a home. Some lenders are now introducing alternative financing options, but affordability concerns continue to dominate the sector.

Cost Pressures

Developers face ongoing cost challenges, exacerbated by higher National Insurance contributions, a new minimum wage, and still-elevated energy prices. These financial pressures are squeezing margins, particularly for SME developers working on smaller projects. Many are turning to alternative financing solutions, including mezzanine funding, to cover rising costs while keeping projects on track.

Stamp Duty and Tax Burdens

Stamp duty has surged, creating steep barriers. For instance, on a £6.5m property recently financed by Davon, stamp duty now amounts to £695,000. This additional tax burden is discouraging high-value transactions and slowing the prime market. Some buyers are now exploring structured finance solutions to manage upfront costs and mitigate liquidity pressures.

Planning Constraints

SME developers continue to struggle with restrictive planning processes. Delays in approvals, coupled with increasingly stringent regulations, are causing setbacks in project timelines. Many smaller firms face uncertainty as planning bottlenecks impact their ability to bring new housing supply to market.

Opportunities Still There

On a positive note, regardless of the challenges out there, we at Davon are continuing to lend. Our focus is on smaller mezzanine loans of £100k to £500k.

We're always looking for experienced developers with a track record of delivering projects who need funding for residential developments with planning consent across the south of the UK.

Last word

It will be another challenging year for SME developers with energy and materials costs still high and brakes on the economy including higher taxes and labour costs.

Low growth limits the Chancellor's ability to stimulate the economy, but there is hope that lower mortgage rates will add some stimulus. Let's hope that by MIPIM next year, the sun will be shining in the south of France, and the market will have warmed up.

www.davon.uk