The UK’s Build-to-Rent (BTR) sector has experienced significant growth in recent years, attracting institutional investors seeking stable, long-term returns. However, the traditional forward funding model, once a cornerstone of BTR development, is facing unprecedented challenges in the current economic climate. Developers are finding it increasingly difficult to secure funding for new schemes, as a confluence of macroeconomic factors and regulatory changes disrupt established financing structures.
1. Interest Rates and the Rising Cost of Capital
Over the past year, the UK’s interest rate environment has undergone significant changes. The Bank of England has gradually reduced the base rate from a peak of 5.25% in August 2023 to 4.25% as of May 2025. Despite these cuts, the cost of capital remains elevated across all layers of development finance — from senior debt through to preferred equity.BBC
What’s driving the pressure:
- Most development loans are now priced over SONIA, which closely tracks the base rate. As of May 20, 2025, SONIA stands at 4.21%. FRED+1YCharts+1
- Typical senior debt margins remain at 2.5–4.5%, resulting in all-in rates of 6.7–8.7%.
- Mezzanine and preferred equity are priced even higher, pushing total capital costs beyond what many appraisals can absorb.
Resulting impact on viability:
- Many schemes that were fundable in a 3–4% interest rate environment no longer stack.
- Developers are having to reduce land costs, delay project starts, or restructure equity layers to maintain viability.
Key takeaway:
Despite recent rate cuts, the cost of capital remains high. Developers must adjust to this environment and underwrite their schemes accordingly.
2. Gilt Yields and the New Risk-Free Benchmark
Institutional investors assess returns relative to “risk-free” alternatives — and in today’s market, UK gilts have repriced significantly. This shift has established a new baseline that real estate investments must now compete with.
Why it matters:
- As of May 2025, the yield on 10-year UK government bonds (gilts) has risen to approximately 4.78%, marking a significant increase from the sub-1% levels observed in 2020. FT Markets
- Pension funds, insurers, and sovereign wealth funds can now secure attractive, predictable returns without assuming development risk.
- This repricing has elevated institutional return expectations, particularly impacting the viability of forward funding deals.
Consequences for development funding:
- Investment deals must now offer higher hurdle rates to justify allocation over these risk-free alternatives.
- Forward funders are seeking lower pricing, more de-risked schemes, or additional incentives such as rent guarantees or step-in rights.
- Many developments that were previously considered viable may no longer provide a sufficient premium over the risk-free rate.
What it means for you:
If your scheme’s stabilized average Internal Rate of Return (IRR) doesn’t meaningfully exceed the current 10-year gilt yield of 4.78% over the investment period, institutional capital may be directed elsewhere.
3. Investor Hurdle Rates Have Increased
In today’s climate, institutional investors aren’t just looking for safety — they’re looking for risk-adjusted outperformance. The minimum return thresholds (“hurdle rates”) that they require for forward funding or equity investment have risen in line with the broader market.
What’s changed:
- Typical hurdle rates for stabilized assets have moved from 4–5% IRR to 5–6%+ in many cases. Reducing yield compression potential and downgrading asset values
- Opportunistic capital now targets 18%+ IRR or more, depending on perceived delivery risk.
- These targets reflect the higher opportunity cost of capital, inflation risk, and market uncertainty.
Developer implications:
- Even marginal cost inflation, delays, or letting risks can push IRRs below fund thresholds.
- Schemes need to show strong fundamentals, clear exit yield assumptions, and robust downside protection.
- Pre-lets, third-party guarantees, and phased delivery are increasingly being used to “de-risk” returns.
Bottom line:
Unless your scheme can outperform fixed income and compete with stabilised acquisitions, you’ll struggle to attract early-stage capital.
4. Construction Cost Inflation vs Rental Growth
One of the core challenges for developers in recent years has been the mismatch between input costs and achievable rents. While build costs have continued to climb, rental growth has not kept pace in most markets.
Key pressure points:
- Materials and labour inflation remain sticky, with tender prices up 25–35% since 2021.
- Contractors are pricing in risk premiums due to supply chain volatility and skills shortages.
- In contrast, rental values — while rising — have often grown at single-digit annual rates.
Impact on development appraisals:
- Gross Development Value (GDV) is increasing more slowly than Total Development Cost (TDC), compressing profit margins.
- Investors and valuers are discounting future rent growth, making appraisals more conservative.
- This leads to lower loan amounts, reduced land residuals, and tighter development contingencies.
Strategic response:
Developers must build more flex into their models, work closely with QS teams to hold costs, and consider modular or offsite methods where appropriate.
5. Forward Funding Structures No Longer Stack
The traditional forward funding model — where the investor funds construction in return for a completed asset at practical completion — has become difficult to justify in today’s market.
Rising costs, compressed yields, and shifting investor requirements mean that many schemes no longer meet return thresholds, especially once developer margin and construction risk are factored in.
Why it’s breaking down:
- Rising build costs have eroded the margin between total development cost and investment value.
- Investors now require greater return spreads to justify early-stage risk.
- Landowners still expecting peak valuations have made residual land values unviable.
- Developer profit expectations haven’t always adjusted to reflect the new funding environment.
What this means:
The once-standard model of “land payment + build funding + 15% margin” is increasingly rare unless the scheme is exceptionally located, fully consented, and backed by a blue-chip developer.
6. Planning Delays and Gateway 2 Risk
The planning system continues to present serious delivery risks, particularly in major urban centres. On top of that, Gateway 2 requirements under the Building Safety Act now add another layer of uncertainty — especially for schemes above 18 metres.
Why it’s material:
- Planning delays stretch project timelines and capital exposure.
- Gateway 2 introduces a formal regulatory stop-go point before construction can begin.
- Late-stage design changes triggered by Gateway 2 review can undermine cost certainty and force redesigns.
For investors, this means:
- Longer timeframes before capital deployment.
- Increased execution risk and exposure to inflation during pre-start.
- Greater emphasis on working with experienced developers who understand how to navigate the Building Safety Regulator process.
Takeaway:
Schemes still pre-Gateway 2 (and not fully through detailed design) face higher scrutiny and often require re-pricing or conditionality to keep investors engaged.
7. Valuation Uncertainty and Low Transactional Evidence
Valuers and investors are struggling to underwrite schemes due to the lack of comparable BTR transactions, particularly for forward-funded stock. While demand for stabilised assets remains, forward funding deals are thin — making it harder to benchmark exit yields or justify assumptions.
Key factors:
- Transaction volumes in BTR have dropped significantly since mid-2022.
- In many regional cities, there are few (if any) recent comps for new-build forward deals.
- Rising interest rates have increased discount rates, but this hasn’t always been reflected in land values or rent projections.
Impact on funding:
- Valuers are often taking conservative stances — affecting loan amounts, funding ratios, and institutional comfort levels.
- Investors are requiring more stress testing of appraisals and may reject schemes with weak supporting evidence.
Developer response:
To mitigate this, schemes must provide highly detailed build costs, local rent comps, operational assumptions, and full sensitivity analysis to support investor sign-off.
8. ESG Compliance as a Gatekeeper
Environmental, Social, and Governance (ESG) compliance is no longer a “nice to have” — it’s a gatekeeper issue for most institutional investors. If your scheme doesn’t meet certain ESG standards, many funds won’t even review the deal.
Common requirements:
- EPC A or minimum EPC B with clear pathway to A
- Net-zero or carbon-reduction strategies (e.g. air source heat pumps, PV arrays)
- Future-proofing of operational emissions and building compliance
- BREEAM, HQM or similar sustainability certifications
Why it matters:
- ESG metrics are now hardwired into fund mandates, particularly for long-income capital.
- Non-compliant schemes may require expensive retrofits or face exit risk at stabilisation.
- Energy efficiency is directly impacting investor pricing and yield expectations.
Bottom line:
Even well-located, high-demand schemes will struggle to get funding if they don’t align with ESG expectations. Developers should embed these criteria from pre-planning onwards, not treat them as post-design bolt-ons.
9. Market Sentiment and Institutional Caution
While the fundamentals of BTR remain strong, overall market sentiment has become increasingly cautious — particularly at the investment committee level. This caution isn’t always about the viability of a single scheme; it’s about the overall risk environment.
Recent issues in adjacent sectors, such as supported housing and mid-market PBSA, have made institutions more selective. Even well-conceived developments are facing more rigorous due diligence and longer approval cycles.
Key themes driving this shift:
- Contagion from distressed sectors (e.g. supported housing governance issues).
- Greater scrutiny on developer delivery track record and operational risk.
- Internal capital deployment constraints across many funds.
- Preference for de-risked, income-generating stock.
Result: Many investors are taking a “wait-and-see” approach or tightening their investment mandates — especially for forward funding structures that rely on future assumptions rather than income in place.
10. Shift Toward Stabilised Assets
In this market, stabilised assets with proven operational performance are king. Institutional investors — especially those with income mandates — are increasingly prioritising core-plus and core BTR stock where leasing risk has already been absorbed.
This doesn’t mean forward funding is dead, but it does mean the bar for pre-completion investment is significantly higher. Investors want to see a track record of delivery, strong local demand, and often some element of pre-letting or operator covenant strength.
What’s changing:
- Greater appetite for forward commitments post-PC rather than funding construction risk.
- Premium pricing available for fully let or nearly stabilised BTR blocks.
- Selective forward funding now reserved for large, proven developers with repeatable delivery platforms.
Implication for developers: Those without scale, pre-let arrangements, or institutional backing may struggle to get forward funding away — regardless of location.
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Conclusion: Navigating the New Funding Landscape
The traditional forward funding model for BTR developments is under significant strain due to a combination of rising costs, regulatory hurdles, and shifting investor preferences. Developers must adapt by exploring alternative funding structures, enhancing project ESG credentials, and demonstrating robust risk mitigation strategies to attract investment.
If you’re seeking guidance on securing funding for your BTR project in this challenging environment, our specialist team is here to help. Contact us today to discuss tailored strategies that align with current market expectations.
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info@letsbuildproperty.co.uk
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