GETTING READY FOR THE NEXT WAVE OF DEVELOPMENT PROJECTS –
IT IS NOT GOING TO BE EASY
With the uncertainty of the Federal Election out of the way, and a number of other positive matters in play such as:
- the upcoming financial boost associated with the forthcoming tax cuts,
- the commitment by the Coalition Government and the Labor Party to assist first home buyers with their home purchase deposits,
- the 25 basis point cut on 4 June (and the increasing likelihood of further cuts) in official interest rates,
- the easing of serviceability requirements used by banks to assess borrowers in terms of their ability to service loans, and
- the likely reduction by APRA of the capital requirements associated with mortgage lending by smaller banks,
- the scene is set for housing prices to trough sooner than would otherwise be the case.
Developers may now be starting to consider new projects for 2020.
In this edition of our Real Estate Investment Alert, we highlight some issues which developers should be aware of when making their future plans. In particular, we will look at:
- Proposed Construction Industry reforms
- Regulatory and tax changes
- The need to do due diligence on non-bank lenders;
- Finance lessons learnt from the current state of the market.
CONSTRUCTION INDUSTRY REFORMS
Although the NSW Government and other States have agreed 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, such reforms have not yet been implemented in some states, including New South Wales.
As mentioned in our February 2019 Alert, once adopted these recommendations are likely to result in the construction industry becoming subject to a large number of additional responsibilities, statutory duties and requirements each of which is likely to increase construction costs.
In addition, the NSW Government has previously indicated that a new Building Commissioner would be appointed to approve new high-rise residential buildings and variations to plans after the design stage. This could lead to further delays in developers getting the approvals they need to commence projects.
In order for developers to be able to finalise their feasibilities for upcoming projects, they will need to consider the impact of the above matters. Until the relevant State Governments finalise and implement these reforms, developers will be faced with ongoing uncertainty in relation to these matters as well as the market generally. This may result in a slower pick-up in development activity than would otherwise be the case.
REGULATORY AND TAX CHANGES
Potential planning law changes in NSW
On 31 May 2019, the New South Wales Planning Minister indicated that the State’s planning laws are likely to change. It appears the changes may result in additional delays and costs for developers when seeking to construct projects which exceed the restrictions in Local Environment Plans (LEP’s). Clearly, these proposals will need to be considered before developers proceed with future projects which are not consistent with existing LEP’s.
Significant stamp duty changes for Victorian developments
In addition to other changes announced, including increases in the additional duty charged to foreign purchasers of Victorian residential property, the Victorian Treasurer has surprised the development industry in that State by proposing changes to the transfer duty payable by developers (on development agreements) and potentially others involved in a project.
The Victorian Duties legislation already includes provisions which can result in developers and others who are regarded as participating in:
- the dividends or income of the landholder, or
- the income, rents or profit derived from the relevant land,
- the capital growth of the land, or
- the proceeds of sale of the land,
or who receive an amount determined by reference to any of the above, (each of which is regarded as being an economic entitlement) as having acquired a proportion of the beneficial interest in the landholder or land. Until now, these provisions did not generally apply if the proportion acquired was less than 50%.
Under the proposed new rules, the duty will apply to any proportion deemed to be acquired although, in the case of a deemed acquisition of a proportion of the land, it is proposed that this will not apply if the value of the land is $1m or less, with the duty then phasing in thereafter. Importantly, if the arrangement under which the economic entitlement arises does not specify the percentage of the economic entitlement acquired (relative to the total of all of the above types of entitlement in the relevant land), the developer or other party will be deemed to have acquired a 100%, unless the Commissioner of Stamp Duties otherwise determines.
The changes, if passed, will potentially have a significant monetary impact on developers and other consultants and agents involved in a project where their fees are treated as being an economic entitlement.
Any transfer of such entitlement will also be liable for duty.
The above-proposed changes may result in developers preferring to undertake new projects in other, more tax friendly, jurisdictions.
THE NEED TO DO DUE DILIGENCE ON NON-BANK LENDERS
In the absence of an appetite by banks to provide development finance, non-bank lenders have been major source of such finance for the last 18 – 24 months.
As mentioned in earlier Real Estate Investment Alerts, due to the diversity of non-bank lenders and the source of their funds, they cannot all be regarded as being the same. Their terms and conditions can be different from those of banks and as between one another. In addition, some of them may not be able to provide funding when required, for example, to meet progress claims.
Their approach to default can also vary, with some of them being less inclined to work through issues with the borrower than others. This matter has, no doubt, been tested over the last few months with settlements of residential sales of new stock not completing, financial ratios being breached and developers going into default.
For this reason, and as non-bank lenders are likely to continue to be a significant source of development finance going forward, it is more important than ever for developers to do due diligence on any non-bank lenders they are thinking of approaching to fund projects.
Dealing with non-bank lenders that have a good track record in terms of funding similar projects, care about their reputation and have demonstrated a willingness to work through issues with their borrowers when a project comes under stress, will be of significant benefit to developers should the market subsequently provide challenges for their project.
FINANCE LESSONS LEARNT FROM THE CURRENT STATE OF THE MARKET
The ability to raise development finance continues to be difficult. The pullback by the major banks from various types of lending has been one of the most significant factors leading to the fall in housing prices.
As expected in a falling market, the relationship between lenders and borrowers is currently being tested by settlement defaults and failure by developers in repaying construction finance on time.
Developers/borrowers who did not sufficiently negotiate their finance documents when entering into their loan will be most at risk of losing control of their project and not recouping their equity, let alone any profit.
To minimise this risk on future projects, developers/borrowers need to ensure that they understand the matters contained in the “fine print” of finance documents before they sign anything as it is these clauses which will determine the level of control over a project given to the financier as well as the parties’ rights when a project is under stress.
As finance documents are drafted by the financier and its lawyers, borrowers cannot assume that their interests are protected by the terms of such documents. Borrowers need to negotiate the terms of the initial term sheet or letter of offer received from their financier before they are signed by the borrower to give them the best chance of achieving acceptable outcomes during the course of the project and when matters turn sour.
For tips on how to improve a borrower’s position under finance documents please download my free Top 10 Tips to improve your Australian Property and Development Finance Outcomes – There is much more to it than just numbers available on our Website at www.peterfaludiconsulting.com.au
If you would like to discuss any of the above please feel free to contact us.
Peter Faludi Consulting
Connect with me on LinkedIn
Subscribe to our Website
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.
Copyright © Peter Faludi Consulting. All rights reserved.