Buyer behaviour in the new build market

When the new build market slows and economic anxiety looms, many people assume that all the buyer’s head for the hills. The reality is this simply is not the case, the market doesn’t stop rather, a different group of buyers become more active.

Cyclical Market

Too often people forget the real estate market is cyclical. First timer buyers (FTB’s) and owner occupiers are most active late in the cycle. A whole different group of buyers re-emerge as the real estate market declines and as the market begins to recover.

So, who are these buyers, when to they buy, what do they buy and why?

Non-Institutional Large Investors

The first to emerge late as the market begins to decline.

Who are they?

These investors typically fall into several groups; small fund managers who represent very high net worth individuals, high net worth individuals acting by themselves, large property investors and family offices (investment business set up by wealthy families to curate their wealth).

When do they Buy?

As the market declines (for whatever reason), developers rapidly find it very difficult to sell their ‘stock’. Developers work to achieving an average sales rate. As their sales rate declines they face a much greater risk of what is referred to in the new-build industry as ‘stock units’. Stock units are essentially new properties which are complete and unsold.

A brief Description of Property Development

To understand why stock units (or stock plots) are such an issue you need to understand how modern development works. Many people have an outdated view of development, where developers buy a parcel of land, build houses or an apartment building and then sell them once they are ready. This is no longer the case; residential development is highly speculative and requires enormous amounts of debt. Most residential developments are sold completely off-plan, this is because the profit in development is only realised once the development has been completely sold out.

To obtain construction debt, developers typically need to pre-sell 30% to 50% of a development. Once these early sales are achieved, developers then look to achieve an average sales rate which aligns with their construction schedule so that the last house or apartment sells before the development completes.

If a developer has completed but unsold apartments (or houses), they cannot realise the profit associated with those unsold plots. In addition, to not being able to able to realise the profit they have ongoing costs such as the cost of marketing the properties for sale, the cost of running a sales and marketing suite as well as the cost of the interest on their construction debt. The longer these plots remain unsold, they erode the developers profit over time.

What do they buy?

These investors buy from developers at points in the cycle when they cannot sell apartments or houses quickly enough.  They buy properties from developers in bulk at a discount.  The developer completes the phase or development and realises their profit and ends their expenses.

What sort of deals do they do and what is their Objective?                                

The advantage of these investors is they are very nimble, they can make decisions quickly and they have large amounts of capital to spend. They generally look to buy property at a ‘discount’ to its open market value (OMV) of circa. 15 – 20%. These investors are generally trying to achieve an enhanced investment yield (reducing the cost with the same rent improves the return) or to sell in the future when the market has recovered and make a capital gain.

Institutional Investors

Institutional investors are active at a similar time to non-institutional large investors but they target different types of investments.

Who are they?

Institutional investors are typically pension funds and other large institutions; they are often referred to as Build to Rent (BTR) funds. They buy high quality residential assets to provide long-term returns to their investors over time. The main difference between institutional investors and large, non-institutional investors, is they only buy whole properties and they are generally only looking for long-term hold.

When do they Buy?

Institutional investors purchase throughout the real estate market cycle. However, they are most active as the market is recovering. The reason for this is simple. They are purchasing a whole property at the point of the cycle where sales volumes are low. Regardless of the point in the market cycle, developers need to keep developing and selling property (it's how they generate their income). If they are concerned they will not be able to sell to smaller investors and owner occupiers prior to the development completing they, will sell the whole development to an institutional investor.

As you may work out, as the market recovers it will become increasingly more difficult for institutional investors to transact with developers. This is simply because as sales rates improve developers, prefer to sell property to other purchasers for where they could achieve a better profit.

What do they buy?

Institutional investors typically buy two types of property:

• Build to Rent Investors – whole residential blocks in city centres and metropolitan areas, they purchase either the freehold (or long leasehold interest).  They generally purchase blocks of 100 to 250 apartments which also include some type of common area where they can provide enhanced residents services such as gyms, concierges, etc.
• Single Family Housing Investors – whole (or whole phases) of housing schemes in popular urban areas.

What sort of deals do they do and what is their objective?                                

Institutional investors purchase property with two types of transaction structures:

• Forward Funding transactions – a transaction where the investor agrees to purchase the whole property from a developer for a specific price, but pays for it in stages as the development is completed.
• Forward Commitment transactions – a transaction where the investors agrees to purchase a whole property for a specific price, they pay a deposit on exchange of contracts with the majority of the purchase price paid on completion of the property.

These transactions are priced based on risk, an investor would expect a larger discount from OMV for a property with a forward funding agreement because the investor is sharing more of the development risk. Discounts vary significantly depending on the type of property buy typically range from 10% to around 20%.

Underwriters

Underwriters are group of investors who many people are not aware of.  They are a very specific type of purchaser who work with developers to reduce their development risk, which they make a profit from.

Who are they?

Underwriters are generally small independent companies, however, some property agents (such as IP Global) and private banks act as underwriters.

When do they buy?

Underwriters don’t actually buy property – they trade it. They agree to transactions with developers as the market is recovering.

What do they Buy?

Underwriters agree to purchase part or all a development (typically apartments) if they cannot sell them.

What sort of deals do they do and what is their objective?                                

Underwriters agree to acquire a large proportion of a development at a significant discount to OMV. They then promote these properties to retail investors and purchasers, generally at a higher price than they have agreed with the developer. The underwriter makes a profit which is the price they sell the property for, less what the property the cost them (the underwriter) and less their costs of marketing.

Offshore buy-to-let investors

Offshore buy-to-let (BtL) investors generally come next in the cycle, they start looking to acquire property as the market is recovering.

Who are they?

Offshore investors for UK property are typically located in Asia and the Middle East.                                                                     

When do they buy?

Offshore buyers typically purchase as the market is declining and as the market is recovering.  At this point in the cycle developers have greater confidence of a market recovery and begin to look to increase their production volume. Developers need to achieve their pre-sales target but at a time when there are very few purchasers around and therefore, they need to look offshore for investors.

What do they Buy?

Offshore investors purchase for a variety of reasons. What they buy depends specifically on what their purpose is. Typically, offshore investors purchase for the following reasons:

• Investment – straight forward buy-to-let for long-term investment
• Immigration – many investors buy because they are planning to relocate to the UK either imminently or at some point in the future.
• Education – many investors purchase property for the future use of their children whilst in college/university, on the basis they hope for their children to study in the UK.

What sort of deals do they do and what is their objective?         

Most offshore investors for UK property buy new build, off-plan. They typically purchase via property exhibitions which are held in capital cities across Asia and the Middle East every weekend. Many large developers have international sales offices in these cities too. This industry is much larger than most people appreciate, for example there are about 1,000 international sales exhibitions in Singapore and Hong Kong, respectively each year.

These investors buy very early in the construction of a building, many of these investors will buy 2 years off plan.  Some developments have been sold 4 years off plan. These investors exchange contracts and put down a deposit of 10% of the purchase price.

These purchases generally buy with a small discount in the region of 5% to the OMV. They purchase for long-term capital appreciation and long-term rental income.

Domestic Buy-to-Let Investors

Domestic buy-to-let investors follow the offshore investors, they start to buy as the market is in recovery mode.

Who are they?

There are approximately 8.6 m households in the UK (46%) who rent the property they live in. Of these, about 4.6 m (53%) are provided by private landlords. Of these landlords:

• 43% own one rental property
• 39% own between two and four properties
• 18% own five or more properties

When do they buy?                                                                                                                                 

When domestic landlords buy, tends to be largely related to their size.  Larger landlords are far more strategic and buy with market cycles, whereas smaller landlords tend to buy later in the cycle as the market is improving and there is greater certainty in terms of market direction.

What do they buy?

Most UK based buy-to-let investors in the UK market buy in the secondary market rather than new build.

What sort of deals do they do and what is their objective?                                

Because of the point in the cycle that domestic buy-to-let investors purchase, and the type of property they buy, they have far less leverage than other investors. In the secondary market, investors typically pay close to OMV and are typically buying for long-term return as a pension.

First Time Buyers

Its only once these markets are in full swing do First Time Buyers return to the market.

Who are they?

First time buyers do not own any other property.  In 2022 there were approximately 370,000 properties (secondhand and new build) bought by first time buyers which accounts for circa 53% of all transactions (source: money.co.uk).

When do they buy?

First time buyers tend to purchase when new build property has completed, or is nearly complete. They buy at the point in time when the 'new build' premium is at it's highest, meaning the property is at it's most expensive.  At this point in time developers will have a marketing suite or show home, helping first time buyers to visualize the property.  

First time buyers will not commit to buying a property without having a mortgage agreed in principal.  Because agreements in principal are typically only valid for 90 days, first time buyers will only commit to buying once a property in complete.  

What do they buy?

Many first time buyers purchase in the secondary market. However, government incentives such as the 'First Homes' scheme, encourages first time buyers to purchase new build property.

What sort of deals do they do and what is their objective?                                

First time buyers will typically pay OMV or close to OMV when buying in the secondary market.  They may be able to leverage a small discount because they are 'chain free' and not dependent on the sale of another property.  When buying new build, because of the type of property they buy (completed or nearly complete) and quantum of property they are buying (i.e. just one), they have the least leverage or any buying group.  First time buyers typically pay the asking price of the property, less any government incentives.