Two headwinds face smaller and less experienced developers in the current market. Those being APRA’s continued efforts to exert pressure on liquidity and more moderate buyer sentiment than we’ve experienced in recent years.
The combination of these two factors presents a significant challenge for MANY developers.
In the current climate, those who wish to see projects through to completion would need to be working with almost 20% debt and 80% equity by the time a DA is approved, in order to obtain construction finance which is typically underwritten by 100% presales (with some developers arriving at levels of 125% of the value of the construction prior to securing finance) if there are no additional assets against which to secure.
This as a result not only of APRA pressure but also timelines on sales and pre-sales. Broadly speaking, the majority of developers are now looking at a 60% borrowing capacity and significantly longer timelines on sales and pre-sales, which in many cases impedes their ability to secure construction finance.
Lenders are factoring in a higher risk to completion – and depending on a developer’s track record, as well as geographic and demographic factors, in many cases they may not acquire the finance necessary to see projects through via the traditional channels.
Experienced Developers to the rescue
With a higher premium on risk, traditional lenders are looking for certainty that projects will be delivered on time, within budget and that they are effectively positioned for timely sales or quality tenancies.
Developers may seek out alternative finance options for their projects, such as mezzanine lenders or private funds – but in some cases, we find lenders are actively calling upon developers with strong track records to step into ‘at-risk’ projects as partners, in order to underpin the successful completion of these developments.
A meeting of interests occurs at this point, where embattled developers seek experienced partners with whom to forge ahead to completion (or in some cases to simply exit with their skin) and established developers are presented with outstanding opportunities to acquire development opportunities at levels previously unseen.
In many cases the opportunity may be for more established developers to bring their experience to bear in positioning problem developments to the market; in some cases, reimagining the product altogether in order to appeal to the most appropriate buyer groups.
Getting in at a discount won’t always mean buying well.
Tighter finance conditions are impacting on consumers too, and as such, depending on geographical locations and quality of product, not all developments will present great opportunities in seeing through to completion in the short term.
With interest-only lending reaching an all-time low at 16.9 per cent in the September quarter of last year, developers should be focused on those areas and products that tend to attract primarily cash-based buyers.
Sydney’s prime market buyers are less susceptible to credit tightening and these areas will continue to see healthy demand.
Also, premium projects that seek to bring high quality products and spacious floor plans to market will continue to attract buyer dollars, as owner-occupier outperform investors, accounting for close to 40% of the market.
Baby boomers aged 55-64 are benefitting from the fastest wealth increases of any other demographic, thanks to increases in the value of their primary residences and the transfer of net wealth from their parents.
18 Month sales horizon versus buying for income
We are seeing more opportunity in the market to buy existing freehold properties – or for the amalgamation of a site with passing income for a healthy yield in the current climate, with future exit potential through growth and/or development approval.
Experienced developers will be attracted to income but also have the capacity to go to market within 18 months when the right opportunity presents.
For those with experience, there is an opportunity at the moment to seek out quality DA sites (perhaps even where there are some presales in place) for 18 month turn around.
With rental rates increasing by 2.7 per cent nationally for the 12 months to December 2017, where a short-term sell out isn’t on the cards, certain JV opportunities may yet present strong value as long term income plays, with an exit in 5-7 years.
Combined capital city rents were 2.6% higher and combined regional market rents increased by 3.0%, indicating that there is still growth to be had and that where an 18-month sales horizon looks unlikely, long-term income can still yield strong results.
Although we’re seeing a tempering of the market at the moment, the underlying demand remains well in tact in those areas where an undersupply persists and where buyers are less susceptible to tighter finance conditions. Owner-occupiers (particularly baby-boomers) looking for quality product in sought-after locations are the bedrock of this demand.
The frenzy of development activity in the cookie-cutter apartment market has left many projects exposed, where tighter finance markets have dampened investor demand.
In the right areas of Sydney, there is a clear opportunity for established organisations to acquire attractive positions in ‘at-risk’ projects, with a view to repositioning them for successful outcomes.