How to improve developer outcomes in 2018-2019

How to improve developer outcomes in 2018-2019

The last 12 months have proven to be challenging to improve developer outcomes with tighter banking restrictions on both development and residential mortgage loans as well as foreign capital restrictions significantly affecting the residential property market.

The need to minimise the adverse impacts of these matters as well as other issues has focussed the attention of participants in residential development on how they can improve developer outcomes and maintain their business in such environment.

In this Alert we highlight two matters which should assist developers and investors in relation to current and future projects:

  • Benefits for developers in using exemption certificates available under our foreign investment regulations
  • The importance of heads of agreement to improve investment outcomes

BENEFITS FOR DEVELOPERS IN USING EXEMPTION CERTIFICATES AVAILABLE UNDER OUR FOREIGN INVESTMENT REGULATIONS

The recently released Foreign Investment Review Board (FIRB) Annual Report for 2016 – 2017 highlighted the significant impact the Foreign Acquisitions and Takeovers regulations can have on developers of residential real estate. In particular, reference was made to the fees payable by foreign purchasers in relation to applications seeking approval to acquire residential property.

Application fees – part of the problem

Unlike other types of real estate (where the application fees are limited or capped in some way), the fees payable by non-business foreign purchasers of residential real estate are not subject to a cap. They currently start at $5,500 for properties purchased for up to $1m, then go to $11,100 for properties purchased for over $1m up to $1,999,999 and then increase by about $11,100 every $1m in purchase price thereafter.

The fees are approximately 1.1% of the purchase price.

Conditional contracts

In the case of any acquisition of real estate by a foreign buyer, the contract for sale must be subject to the buyer obtaining FIRB approval or first having obtained an appropriate exemption certificate from FIRB. This raises uncertainty for the vendor/developer as to whether the sale will proceed.

Developer incentives may overcome the problem

Due to the current slowing market, some developers are offering incentives to buyers of new residential property to try to move unsold or non-settled stock. In relation to the FIRB fees, developers are able to obtain an exemption certificate from FIRB (currently at a cost of $25,700) in respect of individual developments.

In accordance with the conditions of the certificate, the developer is required to pay the FIRB fee applicable to the sale of individual lots to foreign purchasers. These payments are made as part of the obligations imposed by FIRB on developers holding such certificates to report to FIRB on sales made every 6 months.

If a developer proceeds on the basis of such exemption certificate, individual buyers do not need to pay the FIRB fees and can enter into unconditional contracts to purchase the apartment (provided the aggregate purchase price of apartments acquired in the development by the purchaser do not exceed $3m). The ability of purchasers to enter into unconditional contracts should be seen as a positive by both the developer and its financiers.

The FIRB fees could be included in the feasibility for the project as an additional development cost. As a percentage of total costs, this may not be a large impediment to achieving the desired return and would make the development more attractive to foreign purchasers.

Completed projects

It appears that exemption certificates can be sought for completed developments as well as future ones. The definition of new dwelling includes premises that have been built on residential land which have not previously been sold and have not previously been occupied.

In addition, developers can apply for Near New Exemption Certificates, which relate to new dwellings previously contracted to be sold but for which settlement fell through. These provisions indicate that exemption certificates are available for existing stock in completed developments, although this would need to be confirmed with FIRB.

Conditions for obtaining exemption certificates may limit benefits

There are a number of conditions which must be satisfied in order for a developer to be able to obtain the exemption certificate, some of which will preclude certain developers and projects from being able to obtain the certificate. These include that:

  • The development must be for at least 50 dwellings (which cannot be townhouses),
  • Development approval has been obtained, No more than 50% of the lots may be sold to foreign purchasers.

In addition, in assessing an application, FIRB will need to see detailed information about the project including:

  • Marketing plans and budget,
  • The schedule for construction, including stages. FIRB may only grant certificates for stages individually, which may adversely impact the project (where certificates for subsequent stages are not granted),
  •  Architectural plans and concepts, and
  • Information in respect of the units to be built.

The compliance history of the developer vis-a-vis FIRB will also be taken into account.

Conclusion

With application fees being identified as a reason why residential sales to foreign buyers have dropped, developers considering how to overcome this may wish to consider obtaining and complying with the FIRB exemption certificates referred to above.

If the certificates are not available for completed projects, the use of such exemption certificates for future developments should nonetheless be considered as they should overcome, or at least minimise, buyer hesitancy arising from the FIRB application fees payable in respect of a particular property and thereby improve developer outcomes.

THE IMPORTANCE OF HEADS OF AGREEMENT IN DEVELOPMENT DEALS

Knowledge is power when used effectively

The importance of a heads of agreement, memorandum of understanding or term sheet (Initial Documents) is very often underestimated by developers and foreign investors (particularly those unfamiliar with the type of transaction involved or who have not previously been involved in a similar transaction in Australia). These documents are intended to guide parties to a successful conclusion of a transaction. They are the road map which everyone should be following.

When it comes to agreeing to the main terms of a development transaction, all parties need to understand the impact on them of the structure, documentation, financing and legal issues relevant to the deal and ensure that the issues are properly dealt with.

Common high-risk strategy

It is a high-risk strategy to sign Initial Documents without having this knowledge. It is wrong to expect that once a person obtains the knowledge (and consequently wants to use the knowledge to make changes to the transaction) the other parties will agree to changes being made. If the other parties obtained advice before signing the Initial Document, they will be even less inclined to agree to changes that adversely affect them. Renegotiation risk is real and can be very costly.

Examples of issues neglected and adverse outcomes

Finance documents

For example, a term sheet for a loan may provide that standard finance terms (which are set out in another document) will apply to the loan. Many borrowers will not review the standard terms however those terms can include such things as giving the financier the right to change the terms of the loan either from time to time or annually without any qualification. This right is not in the interests of the borrower. If the issue is not identified and discussed with the financier before the term sheet is executed, it may prove very difficult for this to be changed.

A Term sheet may contain a short statement about a restriction which is to apply to the borrower. Unless the borrower fully understands the restriction, it may prove to be unacceptable once its meaning is fully understood. If the term sheet has received credit approval by the financier, the financier is not likely to agree to any change to the restriction.

Parties and structuring

Another common scenario relates to the ability of a party to change the entity involved in the transaction once it has obtained tax advice. If the Initial Document does not contemplate such change, the other party may not agree to the change.

In terms of structuring, the parties need to understand the tax, stamp duty and GST issues associated with the transaction. For example, if the developer already owns the site and its funder/investor wishes to take an ownership interest in either the site or the entity which owns the site, this can lead to adverse stamp duty consequences.

Other matters

Other areas often neglected in Initial Documents include:

  • Decision making and reporting
  • Requirements relating to the builder and construction contract (including related parties)
  • Consequences of default including termination rights relating to the borrower/developer and related parties

Adverse outcomes

In each case, the party seeking the change may have no choice other than to:

  • suffer the adverse tax or commercial consequences,
  • pay the other party some form of consideration for it to agree to the change, or
  • walk away from the deal.

In addition, it is almost certain that increased costs and time delays will be experienced due to the above outcomes and also in circumstances where renegotiation is agreed.

The way forward

As a result, it is important for developers (and indeed all parties involved in a transaction) to understand that Initial Documents:

  • Provide the roadmap/set out the framework to be followed in implementing a transaction, and
  • Should identify and deal with a party’s key issues/concerns.

In order to improve developer outcomes, it is important to identify and properly deal with such key issues/concerns early, thereby minimising the risk of adverse consequences to all parties.

If you would like to discuss any of the above please feel free to contact us.

Peter Faludi Consulting

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The comments made in this Alert do not constitute the provision of any legal, tax or accounting advice by Peter Faludi Consulting or any Director or employee thereof and therefore you should not rely on this Alert in making any decisions relating to present or future transactions in which you are involved. We strongly recommend that you seek legal, tax and/or accounting advice (as relevant) in relation to the same.

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