31st January 2024
Insight
Due diligence upfront mitigates risk to BTR projects

By Paul Belfield, Executive Director at Rund 

In a market defined by interest rates at a 15-year high, inflation, increased energy, fuel and materials costs, not to mention labour and supply chain constraints, the risk factors associated with real estate development and investment have never been higher. In Build to Rent (BTR), it is no surprise therefore that we are witnessing the due diligence process now happening much earlier in the process as developers and investors are ever more cautious, open to any initiatives or interventions that can help them reduce or mitigate risk, as well as seeking help and guidance to negotiate regulation changes, address ESG matters and stay on top of consumer trends so as to better future proof their developments.

To put the scale of the challenge in context, the Knight Frank BTR report for the third quarter of 2023 shows a year-to-date investment of £2.7 billion, with volumes 22% lower than the same nine-month period of 2022, and the third quarter 57% below the £1.6 billion transacted in Q3 last year. However, BTR was down considerably less than other asset types, representing a record 10% of real estate investment in that nine-month period. Meanwhile, the latest RICS UK Construction Monitor puts UK Construction workloads now in negative territory as housebuilding slows, with financial concerns now the key factor constraining the sector.  According to government statistics, 4,165 construction firms went into administration last year, constituting 19% of total insolvencies. Investor apprehension, particularly among European investors identified by INREV as the most risk-averse globally, is causing reduced allocations and potential project delays. 

All of these challenges underscore the importance of due diligence. Consequently, we have seen a noticeable shift towards conducting thorough due diligence far sooner in the process, before contracts have even been signed. This shift represents a constructive step, emphasising the increased necessity for developers and investors to make well-informed decisions about the projects they undertake.

Rund's 2023 industry report highlighted BTR's resilience amidst economic challenges, and despite factors such as materials remaining at a higher level and continuing to impact developers and contractors, all signs point to the market settling in 2024. As we have seen before, the BTR sub-sector is well-placed to navigate the challenges of the wider market and demonstrate resilience. And while the housing crisis is not easing yet, intensifying the supply and demand imbalance, rents may very well increase further as a result, meaning that appetite for high quality rental properties will remain high. 

However, against the backdrop of construction hurdles, financial pressures and escalating rents, there remains a demand and supply imbalance, there is still significant interest and a need to deliver projects. What’s needed is a process to manage a project from the outset in light of constrained cash flow, and debt costs that put pressure on deal structures particularly in the forward funding market, and declining yields, all while ensuring the project is viable and can be delivered.

This is where the trend of upfront due diligence can be hugely advantageous for BTR – as well as Housing Association schemes – as it enables developers to be aware of costs, foreseeing problems and solving them before they sign heads of terms. I bring up Housing Associations due to their reliance on rental income, government grants and borrowings, all of which are being affected by current economic uncertainty. Inflation, together with higher labour and materials prices, and which mean that funds do not stretch as far as may have been projected, which again can lead to caution and stalled schemes. At the same time, there is a need for more affordable rental homes to address the country’s housing crisis, and upfront due diligence can make a difference here. 

In contrast, inadequate due diligence procedures can impede project progress, impacting viability. Gallagher's research indicates that real estate uncertainties have prompted 64% of institutional investors to reconsider funding for projects. Over the last five years, 86% have faced disruptions in their investments, with 45% anticipating lower-than-expected returns. This sentiment fosters risk aversion, leading investors and developers to carefully assess project viability, in turn potentially leading to delayed funding decisions. In planning for delivery, contractors aim to stay competitive in tenders while being cautious about fixed-price contracts, which poses long-term risks for both contractors and sub-contractors.

In-depth and upfront due diligence can help all parties by establishing early risk identification, mitigation and management strategies. This should encompass full pre-acquisition technical due diligence assessments that scrutinise every aspect, from land and site reviews, development funding agreements and technical compliance to design and programme, and project and financial monitoring. It’s the only way to build a truly comprehensive, clear and accurate picture of a development and its associated risks, remove concerns and ensure smooth, timely project delivery. 

By way of example, Rund worked on The Barnum, Grainger plc’s major £55m BTR development on Queen's Road in Nottingham city centre. Just completed, it provides 348 homes along with a mix of best-in-class resident amenities. This was Grainger’s first investment in Nottingham and, as a large and centrally located development, brought many considerations and required a very thorough assessment. Our team carried out the technical due diligence, also acting as project monitor, quantity surveyor and employer’s agent; we managed multiple risk assessment factors, including quality control, financial and technical review. This paved the way for an important development that can support regeneration and provide much-needed, high quality new rental homes in the city. 

Another example is Merrick Place in Southall, where Rund carried out project monitoring and technical due diligence services for Grainger plc and Network Homes on a £200m development set to dramatically transform a brownfield site. The technical due diligence we carried out was instrumental in getting this 575-home development off the ground. Through our research and analysis of the physical characteristics of the development we ensured that Merrick Place would meet all of the necessary technical and operational requirements.

Due diligence is no longer just a checks and balances process, and will increasingly inform decision-making, determining if sites are bought and projects progressed. Early visibility of risks and transparency from the earliest stages and across the lifespan of projects, can empower companies to acquire significant sites and future-proof assets. Putting due diligence first adds an additional layer of assurance and helps more schemes be brought forward at a time when the demand for homes has never been higher.


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