REAL ESTATE INVESTMENT ALERT NO. 18
The appearance of cracks in the Opal Tower building at Olympic Park in Sydney on Christmas Eve 2018 may be remembered as either being an isolated incident which is not reflective of the construction standards followed in Australia or the start of a new stressful phase in the increasingly difficult development market in Australia.
Although comments have been made by a number of developers that the circumstances of Opal Tower do not indicate an iindustry-wideproblem, it was interesting to read of other recently constructed buildings containing a large number of defects. It was even more interesting to read articles highlighting that private certifiers are not necessarily qualified engineers and that some builders are not sufficiently familiar with the use of “pre-fabricated concrete panels” (which are being increasingly used in construction projects).
No doubt Opal Tower will continue to be in the news until the source of the problem with that building is identified and dealt with. In addition, it is likely that there will be more and more articles about other developments with problems as unhappy purchasers look to ways in which they can improve their position in a falling market.
In this edition of our Real Estate Investment Alert we consider some possible flow on effects of the Opal Tower incident, in particular:
- Will the strata defect bond scheme alleviate the adverse consequences to owners of strata lots; and
- the effect on access to construction financing.
We also have a SNEAK PEAK at my upcoming book with an extract from it relevant to the above matters.
WILL THE STRATA DEFECTS BOND SCHEME ALLEVIATE THE ADVERSE CONSEQUENCES TO OWNERS OF STRATA LOTS
As mentioned in our January 2018 Newsletter, since 1 January 2018, developers of residential or partially residential real estate in New South Wales (involving three or more floors) have been required to comply with the Strata Defects Bond Regime established under existing Strata Schemes legislation.
This requirement applies to any work carried out under a construction contract entered into on or after 1 January 2018 (or commenced on or after that date where there is no construction contract in place). As the Opal Tower was likely to have been constructed under a contract dated prior to 1 January 2018, this regime does not apply to it.
Under the regime, residential property developers must arrange for a bond or similar undertaking (covering an amount of 2% of the building contract price) to be lodged with the Department of Finance, Services and Innovation prior to the issue of an occupation certificate in respect of the development.
In addition, the developer must engage inspectors to carry out interim and final defects inspections. The inspector must be on a strata inspector panel, such as that established by the Master Builders’ Association. The interim inspection is to be done between 15 and 18 months after completion of the works, with the final inspection to be done between 21 and 24 months after completion.
The owners’ corporation may claim amounts under the bond to cover defect rectification work up to the later of 2 years after the completion of the works and 60 days after the lodgement of the final report by the inspector. This essentially means that the developer is subject to a longer defect liability period than the usual 12 months period provided for in construction contracts.
Had Opal Tower been subject to the above regime, the purchasers would have had the benefit of additional independent scrutiny as to whether the building had met all required standards as well as access to funds available to cover the costs of rectifying the defects (given the issue was discovered prior to the expiry of the above mentioned claiming period).
The strata defects bond regime is therefore an example of a recent regulatory development in New South Wales which should reduce the risk of defects occurring and, if they do occur, give comfort to purchasers that the cost of rectifying any defects identified (within the period mentioned above) will be at least partially (if not fully) funded.
THE EFFECT ON ACCESS TO CONSTRUCTION FINANCING
There are a number of likely outcomes from the Opal Tower incident which will make it increasingly difficult for developers, other than top tier developers using top tier builders, to obtain construction/development finance.
Two of the most critical conditions precedent which must be satisfactory to a construction financier before it will agree to fund a project are:
- the developer having entered into a sufficient number of qualifying pre-sale contracts; and
the builder and building contract being acceptable to the financier.
- Given the Opal Tower incident, as well as the current falling market and credit restrictions, entering into the required number of qualifying pre-sale contracts will be more difficult than has previously been the case.
The use of builders (and other consultants engaged in the project) with good track records and market reputations has always been an important element in getting construction finance. Irrespective of the outcome of the investigations into the Opal Tower incident, it is likely that financiers will have even stricter requirements in relation to this condition which is likely to have adverse cost and feasibility consequences for developers.
SNEAK PEAK from upcoming Peter Faludi Consulting book
The use of builders and consultants that have a recognised proven Australian track record can make the difference between success and failure in getting finance
In the current market, it is virtually impossible to obtain property finance for a development if the developer has no proven track record in Australia for similar projects. For foreign investors, the problem is even more acute as they may not have any experience in the Australian market at all.
For a financier to be comfortable in providing a loan to a developer in this situation, it is imperative that the developer has well-known, good quality and experienced advisers, consultants and builders involved in the project. It is the track record and quality of these advisers, builders and consultants that will impress the financier and give it comfort that issues associated with the project will be minimised due to the involvement of such parties.
Tip: It is imperative that developers engage builders and consultants in the project that have an excellent proven Australian track record as this will substantially improve the likelihood of obtaining construction finance.
In the case of pre-sale contracts, developers/borrowers will often agree to vary the terms of their master sale contract to get potential purchasers to exchange contracts. Unfortunately, such variations can lead to particular contracts not satisfying the financier’s pre-sale contract requirements and so will not be regarded as complying or qualifying pre-sales. Similar consequences would apply in relation to a failure to meet other financier requirements relating to pre-sales such as limits on the number of foreign buyers and the sunset dates included in the contract.
Generally, unless the developer/borrower has entered into sufficient complying or qualifying pre-sale contracts as required by the financier, the financier will not agree to provide any construction funding or potentially any funding at all.
Tip: It is critical to ensure pre-sales contracts are on terms that satisfy the requirements of the financier otherwise funding will not be provided. Your lawyer should be familiar with the pre-sale requirements of the financier before agreeing to negotiate any changes to standard pre-sale contracts.
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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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