Earlier this month, Dani Netzer, Lending Manager at Blend Network, shared his thoughts in Mortgage Introducer magazine on how lenders have changed their criteria in the face of rising cost of materials. If you missed it, you can read it in this link or below.
Housebuilders costs increased by 1.7% in Q1 2021 and by 3.6% between Q1 2020 and Q1 2021[i]. This sharp increase in building materials costs affects the delicate nature of the housing sector with severe implications to homebuilders, and of course also to development finance lenders like us at Blend Network. So, here we bring you our thoughts on how lenders are adjusting to rising costs, and what borrowers need to know to also help them navigate this environment of ever-changing prices and uncertainty.
According to the Office for National Statistics, prices of products of wood, cork, straw, and plaiting materials have been on the increase since April 2020, with 17 consecutive months of price increase peaking in September 2021, an increase of 25.1% from September 2020[ii]. The construction materials price index is at its highest point since current records began in 1996[iii]. On top of the supply chain crisis, HGV-driver shortage is adding to delivery problems and hitting the supply of materials like cement, concrete roof tiles and bricks. This significant rise in building materials costs affects the delicate nature of the housing sector with severe implications to homebuilders who commit to contracts months in advance of price changes. So, how are development finance lenders adjusting to navigate the rising material costs?
My colleague Daniel Netzer, Lending Manager and Senior Underwriter here at Blend Network shares his thoughts and explains that “in an ever changing climate of rising building material costs, lenders should pay very close attention to the contract between the borrower and the contractor”. For example, in the US, the National Association of Homebuilders’ Construction Liability, Risk Management and Building Materials Committee recently published a contract appendix for property developers to use in their construction contracts that provides an ‘Escalation Clause for Specified Building Materials’[iv]. These changes to ‘fixed-price’ contracts act more like ‘cost-plus’ conracts where borrowers assume the risk of rising materials costs”.
“Ultimately, rising material costs threaten homebuilders’ ability to complete the project while maintaining a profit” explains Daniel Netzer. Thinly capitalized developers may not be able to, or may not want to, absorb additional costs under ‘fixed-price’ contracts, particularly in high-demand markets where there’s an incentive to just walk away for more profitable work.
Generally, there are three ways lenders have adjusted and changed their lending criteria in the face of rising cost of materials to navigate the new more uncertain price environment. “The first way is to require higher contingencies and contingency reserve accounts. The second way it more integration on supply chain and materials used on site (e.g. where are the bricks made in? Are tiles made in Turkey or in the UK). And the third way is by an increased focus on the financial standing of the borrower’s main contractor” says Daniel Netzer. So, our advice to borrowers right now would be: make sure you are using a contractor of fixed price and that you are comfortable the contractor can deliver with that fixed price, make sure that your risk as a developer is one that you are comfortable with, and finally and most importantly, make sure that your numbers are strong enough to sustain sudden and unforeseen price rises.
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[i] Source: https://bit.ly/3o35laY
[ii] Source: https://bit.ly/3bLsmJO
[iii] Source: https://bit.ly/3GUv0Lt
[iv] Source: https://bit.ly/3mV3Ufv