By Ritchie Clapson CEng MIStructE, co-founder of propertyCEO
People always seem to be a little sceptical when they hear stories of fortunes being made in the middle of an economic downturn, financial meltdown, or housing crisis. Exactly who are these people with the presence of mind or inside knowledge to forecast such things and then invest in such a way that they profit spectacularly?
Meanwhile, everyone else watches on from the side-lines, either licking their wounds or simply waiting out the storm, too scared to invest, wondering if these people have some sort of advantage over everyone else? Perhaps they subscribe to a particularly good tipster, or maybe their crystal balls just work better. It could, of course, simply be that they were lucky; timing is everything, and it could just be a happy accident.
Whatever the reason, you cannot deny they have been successful. Turn the clock back to any recession, and you will find a small but significant group of investors who bucked the trend and made millions. It was Warren Buffet who said: when others are greedy, be fearful – and when others are fearful, be greedy. With such advice coming from someone who knows his onions when it comes to making money, it is fair to say it probably isn’t all down to luck, blind faith, or bloody-mindedness.
I should start by saying that I have witnessed a few recessions, meltdowns, and crises over the years. The most recent one occurred in 2008, when the economic downturn saw house prices plunge by around 15%, which represents a major correction in historical terms. I was recently asked whether, armed with all this hindsight, it was possible to look at what the most successful investors did during previous downturns and develop a successful formula for profiting from the current economic crisis. So here goes.
Not all downturns are created equal
Downturns not only come in different strengths, but they also come in different flavours. As a result, there is never going to be a one-size-fits-all solution to making money in a downturn since the underlying drivers will differ from one situation to the next. What does hold true in every downturn is that you need to be selective. The big winners won’t simply be lucky, they will have invested intelligently and spotted opportunities in the prevailing market conditions.
The other reason that downturns represent such great opportunities is that there is less competition and a greater chance for bigger market swings. Timing, in that respect, is critical. The bigger the downturn, the greater the benefit, particularly if you are able to hop on the bus when it reaches the bottom of the market.
If we look at the property landscape over the recent past, the smart money has moved from buy-to-let investing to small-scale development. There are no real surprises here as the government continues to tax and regulate buy-to-let landlords to oblivion with little sign of things letting up any time soon. But that very same government is also desperate to have people build new homes, so it has taken steps to make smaller development projects as attractive as possible. The undeniable sweet spot is projects that involve converting brownfield sites into residential use, such as office conversions or putting flats above shops. This is mainly because these types of projects now have permitted development rights that allow you to change the use of the building without all the hassle and risk associated with gaining full planning permission.
Big is beautiful
But what about smaller projects such as house flips and refurbs? Unfortunately, these aren’t going to work so well in a market where property prices are falling. You ideally want to be flipping at a time when the asset you are refurbishing is increasing in value month on month, not dropping. With house prices continuing to fall in 2023, you will be swimming against the tide. Better to wait until 2024/5, when prices are likely to be on the rise again.
So, why could the timing be perfect for tackling a small-scale development project? Three key cost factors are involved in any development project: the price you pay for the asset you are going to develop, the cost of doing the development work, and the price you sell your finished units for. If you can optimise all three of these, you will be on to a winner.
The cost of the asset
Asset acquisition means buying some type of commercial property or shop. As the economic downturn continues to bite, more businesses will struggle to survive. Some will go bust, while others will sell off assets such as property resulting in more properties in the market, which, in turn, puts downward pressure on prices.
Also, many commercial landlords have been holding out, hoping to sell their properties to developers for top dollar. Only now they have a problem. Not only are commercial property values on the way down, but the cost of maintaining those properties has gone up significantly. Mortgage repayments, energy costs, not to mention security, and general maintenance – all of these have increased. It has created a situation where the value of their property is decreasing, and the costs of maintaining it are growing. In other words, the sooner they sell, the more money they will make. This will lead to many more commercial properties hitting the market in 2023, adding to the downward pressure on prices. It is difficult to predict precisely when the market will bottom out, but somewhere from mid-2023 to early 2024 would be my guess. So, you should be able to lock in some excellent value by buying this year.
The cost of developing
Developing costs include the cost of materials and labour, as well as the finance costs and professional fees. Much has been written about the cost of materials and labour following the global pandemic and the war in Ukraine. However, there is a real prospect that late 2023 to mid-2024 could see a significant reduction in costs. The major housebuilders have a big impact here. As house prices start to fall, so the Barratt Homes and Persimmons of this world begin to put their developments on ice. Existing projects will be built out more slowly, and new projects slated for 2023 will be deferred. They have no appetite to build in a falling market – far better for them to wait until the market is buoyant again. As housebuilders stop building, so the demand for labour and materials decreases causing prices to drop significantly. We started to see this messaging from several housebuilders in late 2022, and as house prices look set to fall throughout 2023, there is nothing to suggest that this will change. Consequently, the best time to look for materials and labour might be from late 2023 through to mid-2024.
Selling price of your finished development
House prices have increased around 20% in the last two years, however most knowledgeable commentators predict that 2023 will see a 5-10% reduction in values. Even the Office for Budget Responsibility (OBR) is predicting a 9% reduction between now and Autumn 2024, although, as they have yet to get any of their previous predictions bang on, no one is betting the house on it. But one consistent forecast is that house prices will start to increase in late 2024 and make solid upwards progress throughout 2025. In other words, you ideally want to be selling swanky new apartments in late 2024 onwards to hit a rising market.
Hopefully, you can see that there is a potential perfect storm here, and the timing could work out very nicely. Having secured your commercial property at the bottom of the market in mid-2023, you will be tendering in late 2023 or early 2024, when labour and materials prices should be much lower than they are today. After completing the conversion, you then put your lovely new flats on the market in late 2024 or early 2025, when property prices are rising again. It’s a perfect triple-whammy.
But what happens if your timing is off?
If the market hasn’t bounced back by the time you come to sell, that is where developers have a distinct advantage as they can always rent out their finished projects instead of selling them. We have seen in the current market how a lack of affordability has not only created downward pressure on house prices, but it has also pushed more people into the rental sector. This, in turn, has caused rents to go up significantly. So, if you find that you would rather defer the sale of your finished units, you could simply refinance them onto a buy-to-let mortgage, pay back the development finance and then rent them out profitably until house prices have recovered. It’s the perfect Plan B.
Summary
Remember that there are no guarantees, but hopefully you can see the simple logic involved. What should you do while you are waiting to bag a cut-price commercial property in mid-2023? My strong recommendation is to get yourself educated. Taking on these small-scale development projects requires less capital and less work from you as a developer than doing a simple refurb. But you have got to know what you are doing, plus you have got to know how to find the best opportunities. If you would like some free training to get a better idea of what is involved, you could head to propertyceo.co.uk, where there are lots of free resources for aspiring developers and those looking to understand what is involved. Armed with both skills, you should be able to steal a march on the countless other people looking to develop property in 2023.
ABOUT THE AUTHOR
Ritchie Clapson CEngMIStructE is an established developer, author, industry commentator, and co-founder of leading property development training company propertyCEO. To discover how you can get into property development, visit www.propertyceo.co.uk
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