[+] Apartment Developers ‘Must Be Brave’

Apartment buyers will have to absorb higher prices if the industry is to get moving once more in Melbourne. That’s the advice from Charter Keck Cramer’s Richard Temlett, who says developers are regularly asking him if values and prices can push higher in what is being billed as one of the toughest build-to-sell markets on record. “Prices just don’t stack up anymore,” Temlett says. And he is right. A recent Australian Constructors Association report quantifies the problem, it’s all risk and no reward with profit margins sitting at 1 per cent and liquidity about 5 per cent. The report outlines the fundamental problem with fixed-price contracts that are white-anting the viability of the construction sector and causing uncertainty in pricing projects. Temlett says the market needs to recalibrate. The cost of land and construction is not going backwards, and the Charter Keck Cramer national executive director says pushing apartment prices up is the only way to release the gridlock in Melbourne’s undersupplied market. “Industry needs to be brave, and is being brave in terms of pricing, but there’s a lot of logical reasoning behind putting prices up. “Prices will recalibrate. They shouldn’t jump 15 per cent in a balanced market. But this isn’t a balanced market. Prices do go up but it’s at a much slower rate in a balanced market. “Value rates of $10,000 per square metre pre-Covid are now closer to $12,000, and off-the-plan value rate of $12,000 per sq m is now closer to $14,000 per square metre.” Melbourne apartment supply by launch year Source: Charter Keck Cramer Charter Keck Cramer looked at 10 suburbs across Melbourne to develop insights into the build-to-sell apartment market, which has stalled amid high inflation and ongoing interest rate hikes. Temlett says some off-the-plan sales prices had increased 2-3 per cent, while others had increased by 15 to 25 per cent. He says apartments in the west had increased significantly but they were coming off a low base and that it was owner-occupier targeted developments that were primarily transacting. He also says the two-bedroom two-bathroom typology had grown in popularity and was attracting higher price growth compared to the one-bedroom apartments. Temlett says research shows apartments being sold off the plan have pushed value rates 15 to 25 per cent in 2023. While sales may be slower, there is evidence of market acceptance of higher pricing. The gap between house and apartment price growth is still significant. House prices have increased 20 per cent and buyers are being priced out of the market. The long-term (10-year) gap between house and units in Melbourne has been 47 per cent. The current short-term (2-year) gap is 60 per cent. This is a function of the significant market distortions caused as a result of Covid where detached house prices increased 24 per cent between 2020-2022. “There’s a huge gap between houses and apartments. The economic costs of delivery are at a very different point, but the market is not going to shut down—people are going to have to make a trade-off,” Temlett says. “Sheer population growth will put a floor on pricing. “There’s a pool of buyers that 12 months ago could buy a house, but now that has fundamentally changed. They still want to get into the housing markets but they may have to move to the townhouse market.” Melbourne house and apartment median prices Source: ABS, Corelogic, Charter Keck Cramer Without strong evidence of market appetite for higher prices it will be difficult for developers to secure funding. Temlett says good projects and good developers should be able to attract investment—but he says government support would help grease the wheel. “The government needs to look at tax breaks to bring local and foreign investors (into the market). The apartment market needs to be stimulated to bring buyers back to market, with things like removing stamp duty and replacing it with an annual land tax, similar to what was initially trialled in NSW,” Temlett says. New entrants into the development sector, particularly in the build-to-sell apartment space, will find it very challenging to attract capital. But it’s not just that. Getting your project built presents some huge hurdles as building firms enter administration at more than twice the rate of other industries in 2023. Non-bank lender MaxCap is continuing its heavy focus on contractor risk mitigation through 2023. “I’m often asked what keeps me up at night, and it’s the contractor risk and what’s going on with building prices. The reality is there are a lot of feasibilities that aren’t stacking up,” MaxCap chief investment officer Bill McWilliams says. ▲ Richard Temlett says good projects and good developers should be able to attract investment. Australian Constructors Association head of policy Robert Sobyra says in the year to March 2023, builders failed at a rate of 619 per 100,000 firms. The rate for the rest of the economy was 270. Sobyra says the industry has become “dysfunctional” and it’s a “textbook example of market failure”. The fixed-price contract is transferring all the risk to the seller, which Sobyra says means “an inordinate burden of risk around ground conditions, design details, weather, and third-party interfaces”. “When those risks are realised, they are funded out of profits,” Sobyra says. “Extrapolate that pattern of total risk transfer across time and you get a deeply unstable industry characterised by systemically weak financials, a myopic short term focus, litigiousness and adversarial ‘sharp practices’. Welcome to construction—the lawyer’s playground.” Sobyra says builders are cooling their jets waiting for a more attractive risk proposition rather than taking on projects in the current climate. He says taking on a more collaborative approach from the outset could help create better outcomes for the development sector. This sentiment is mirrored by many across the industry as a rationalisation of projects washes through. Colliers managing director for project leaders Jon Barnes says the cost of construction is largely being drive by labour costs. Construction costs remain 20 to 25 per cent above pre-pandemic levels, according to Barnes, and this is not likely to come down while the state and federal governments push infrastructure projects through the pipeline. “It is likely that pressure on construction costs will continue,” Barnes says. “It’s clear that increased construction costs will not abate and that now more than ever principals, owners and developers will need to share the risk and work more closely with construction contractors to deliver projects. “The one big upside to all of this is that it may bring the possibility of providing some equity of risk between construction contractors and principal owners.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

[+] Apartment Developers ‘Must Be Brave’

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