Since our January 2019 Newsletter, in which we touched on some possible consequences flowing from the Opal Tower situation in NSW, three major announcements have been made which are likely to have long term structural impacts on property development in Australia and result in a more expensive environment in which to undertake property development.
The new world of development
The three announcements are:
- The release of the Haynes Royal Commission Report on the financial services industry;
- The agreement of the NSW Government and other States to adopt the majority of the recommendations in the Building Confidence Report prepared by Western Sydney University Chancellor Peter Shergold and lawyer Bronwyn Weir (Building Confidence Report) on the construction industry and the agreement of various State Ministers to impose substantial consumer protection laws on builders and consultants involved in construction projects; and
- The move by all States and Territories to ban the use of certain types of cladding, commonly used in high rise developments, due to safety concerns.
In this edition of our Real Estate Investment Alert, we consider the likely impact of these announcements on property development and the financing of projects. In particular, how will these announcements and the reforms to follow impact on:
- Project Costs;
- Market trends.
Mortgage broker remuneration
One of the major changes put forward by the Haynes Royal Commission Report relates to how mortgage brokers are remunerated. Although they act for borrowers by helping them find finance, they are remunerated by the financier with which they place the loan. Such remuneration is in the form of an upfront commission and an ongoing or trail commission, in each case being a percentage of the loan.
This has raised the ire of the Commission as it arguably results in a conflict of interest. Does the broker help the borrower obtain the best loan possible to satisfy the borrower’s requirements or are loans recommended simply on the basis of which financier pays the broker the highest commissions? If the latter, is the broker really acting in the best interests of the borrower?
The issue has raised the question of whether borrowers would be better off merely paying the broker a fee for service, with the broker not receiving any remuneration from the financier.
A number of arguments have been put forward to counter the conclusion of the Royal Commission, including that if the fee for service model was adopted, borrowers would not be likely to pay the fee and would thereby tend to obtain finance from the major banks (and as a result further strengthen the market power of the banks). In addition, many brokers would potentially fail if the fee for service model was adopted.
Importance of mortgage brokers
In the current difficult financing market, having professional brokers who know the market and the participants in it which have money to deploy and an appetite to lend (which now includes a large number of non-bank lenders which are not widely known by borrowers) is an invaluable service for borrowers. If the broking industry was to shrink substantially due to adoption of the Royal Commission recommendations, the availability of this service would be reduced and, given the difficulties in obtaining bank finance, borrowers would find it harder to buy their home and/or investment properties.
Impact on presales
As the majority of home and investment home loans are arranged through brokers, the unavailability of a strong broking industry to facilitate obtaining such finance will substantially add to the existing difficulties for developers to achieve the level of presales required by their financiers. Consequently, a large number of developers would not be able to raise finance and the construction of new residential premises (particularly high-rise developments) could fall dramatically.
Suggestions for mortgage brokers
While the debate on remuneration structures will no doubt go on for some time, it may be appropriate for brokers to consider:
- what they could do to demonstrate to both the regulators and potential borrowers that they are, indeed, acting in the best interests of the borrower; and
- how their remunerations structures could be modified to alleviate the concerns which have been raised.
The Opal Tower fiasco has bought to light the issues associated with qualifications and experience of the builders, engineers and other consultants involved in construction projects.
The various State Ministers involved with building and construction recently met to consider what measures could be taken to minimise a repeat of the Opal Tower situation as well as the risks associated with external cladding. They also indicated they will adopt the majority of the recommendations made in the Building Confidence Report.
The new regulatory environment
As a result of these meetings and the likely adoption of the Building Confidence Report, the construction industry will become subject to a large number of additional responsibilities, statutory duties and requirements this year, including:
- builders, engineers and other consultants involved in residential construction projects being subject to a statutory duty of care in favour of present and future building owners in relation to the quality of construction and compliance with relevant building codes;
- each state or territory implementing registration schemes for builders, surveyors, architects, engineers, designers, and inspectors involved in the construction industry;
- the above parties being subject to training and licensing requirements administered by a new Building Commissioner;
- in NSW, the new Building Commissioner having to approve new high-rise residential buildings and variations to plans after the design stage.
Impact on Project Costs
Although the above measures are clearly welcome from a health and safety point of view, it is likely that they will result in additional costs and substantial additional risks for each consultant involved in a project which will be factored into the total project costs
This additional cost will need to be financed potentially resulting in a higher level of required presales. Whether this can be achieved in the current market will need to be seen.
As a result of current market trends, we are already seeing a shift in the type of projects developers and financiers wish to be involved with.
The difficulty in getting sufficient presales for high-rise residential apartments as well as the falling residential market is driving developers and their financiers in favour of medium density/low rise projects. Some financiers are moving away from development financing preferring to provide simpler acquisition/investment finance for office and industrial property.
With the above reforms set to potentially add further costs and presale difficulties in respect of high-rise residential developments, 2019 may be a year where the number of commencements for such developments is substantially less than in previous years.
Perversely, this could assist in stabilising housing prices.
An interesting year for sure.
If you would like to discuss any of the above please feel free to contact us.
Peter Faludi Consulting
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