REAL ESTATE INVESTMENT ALERT
The downside of proposed NSW Building Reforms
The NSW Minister for Better Regulation and Innovation, Kevin Anderson, recently released further proposals (including a rating system for developers, builders and certifiers) to be considered as part of the new regulatory regime intended to improve building standards. The regime is to be adopted once the NSW Government is able to get agreement from opposition parties in the NSW upper house.
As mentioned in a number of our previous Newsletters, (see most recently our November 2019 edition), the proposed reforms will have a major effect on the property development industry. The proposal put forward by Mr Anderson has further highlighted this.
In this edition of our Real Estate Investment Alert we discuss:
- The nature of the proposed new regime
- The consequences of the regime for:
- Developers and builders
NATURE OF PROPOSED NEW REGIME
Main new requirements
The proposed new regime is to apply to building and development in NSW and is currently set out the Design and Building Practitioners Bill 2019 (NSW)(Bill). Although the Bill was passed by the NSW Legislative Assembly on 13 November 2019, it was withdrawn from the Upper House late last year due to lack of agreement by opposition and minor parties in the NSW Upper House.
In addition to the Bill, regulations will deal with a large number of significant and operational matters which are only referred to in the Bill at a high level. No draft regulations are currently available.
Once finalised, it is likely that similar reforms will be rolled out in the other states and territories.
The Bill includes the following:
- registration requirements for design, principal design and building practitioners (each as defined in the Bill),
- a requirement for compliance declarations to be provided by such practitioners in relation to design and building works. The declarations will include verification by the relevant practitioner that the design and works are compliant with the Building Code of Australia and other applicable requirements as may be specified in the regulations,
- limits on who can issue compliance declarations – must be registered practitioners,
- a requirement that practitioners must provide verification that they are covered by adequate insurance,
- a potential prohibition on the issue of building certificates without relevant compliance declarations first having been provided to the issuing authority,
- a potential prohibition on the issue of Occupation Certificates in respect of a building to which the Bill applies until all required compliance declarations are provided to the relevant certifier,
- a prohibition on registered practitioners or other persons entering into understandings under which the practitioner is to act other than impartially in relation to the issue of a declaration,
- an extended statutory duty of care to exercise reasonable care to avoid to economic loss caused by defects. This duty extends to each owner of the land for which the works were carried out and each subsequent owner. In addition, the duty cannot be contracted out of or delegated to someone else. Importantly, this duty will have retrospective application and it appears that, in any action enforcing the duty, a reverse onus of proof may apply to the relevant practitioner(s),
- extensive investigation, information gathering and similar powers for “authorised officers” in respect of monitoring and enforcing compliance with the regime, and
- the imposition of penalties.
Impact of Regulations
As mentioned above, a large number of significant matters which developers, designers and builders will need to know in order to comply with the new law will be set out in regulations to the Bill. Until drafts of such regulations are issued, it will be difficult for participants in the development industry to fully understand how the new regime will impact their business and how to prepare for it.
The regulations will cover such fundamental matters as:
- the types of buildings to which the new regime applies,
- the form and content of the various compliance declarations,
- the documents required to accompany the compliance declarations,
- when and to whom the compliance declarations need to be provided,
- the insurance requirements to be met in order to comply with the Bill.
It is likely the rating system proposed by the Government will also be dealt with by the Regulations.
STOP ORDERS, PUBLISHED WARNING NOTICES AND OTHER MATTERS
The Bill gives powers to the Secretary of the NSW Department of Customer Service to issue Stop Orders to a building practitioner or the owner of land on which works are being carried out to stop the works if, in the opinion of the Secretary:
- “the building work is, or is likely to be, carried out in contravention of the Act; or
- the contravention could result in significant harm or loss to the public or occupiers, or potential occupiers, of the building to which the work relates or significant damage to property.”
It appears such Stop Orders could be effective for upto 12 months unless revoked earlier.
Published warning notices
In addition to Stop Orders, the Secretary will have the power to publish a notice, warning persons of particular risks involved in dealing with:
- “a specified registered practitioner or former registered practitioner; or
- any other person the Secretary reasonably believes may have breached the Act or regulations.”
Proposed Rating System
In Kevin Anderson’s release of 20 January 2020, he put forward additional factors which purchasers could consider when assessing their potential risks in dealing with particular developers or builders.
He suggested a quality rating system for builders, certifiers and developers which would allow NSW Building Commissioner the power to block the issue of the occupation certificate for a project if the project was deemed to be unsafe.
Failure of the developer to obtain an occupation certificate would, if it was not able to be obtained prior to the sunset date specified in the sales contracts for the project, require a refund of deposits to purchasers.
CONSEQUENCES OF PROPOSED REGIME
Developers and builders
Although the regulations to the Bill could extend its operation to any type of building, it is clear that the proposed regime is intended to substantially raise the standard and quality of building of high-rise residential projects.
As you will have seen from the above high-level summary of the current Bill, the NSW Government has adopted a very stringent approach to regulation. It is essentially warning that unless the design and building practitioners involved in these types of developments meet the required standards and stand by their project for the benefit of current and future owners, they will eventually be unable to carry on their business.
Additional costs and uncertainty
The proposed changes will result in additional costs being incurred by developers, designer and building practitioners, particularly in respect of high-rise residential developments. The uncertainty as to the timing and nature of a number of these changes will place additional pressure on developers and such practitioners and potentially make it harder to undertake these types of developments.
Adverse impact on sales and finance
To the extent developers, designers and building practitioners do not meet the new standards to be imposed by the new regime, or will not receive the required quality rating, their business is likely to suffer. In addition to increased difficulty in winning projects, financiers may not wish to deal with those developers and practitioners thereby making it harder for them to continue their business.
Start getting ready for the new regulatory world
Developers, designers and building practitioners will need to ensure they get advice on the various regulatory changes that may impact their business as soon as possible to make sure that they:
- understand which, if any, changes will affect them or individual projects,
- structure or change the type of projects they are involved with to account for the reforms,
- factor the costs of the changes into their feasibilities for future projects,
- adjust their processes to be compliant with the new rules once they take effect, and
- demonstrate to their financiers that they are on top of these issues and can satisfy any requirements their financier may have in relation to the changes.
Consequences of the proposed rating system
As the proposed rating system will be based on historic information, it is likely to adversely impact on existing developers, designers and building practitioners who may not have an unblemished track record, even if the above preparations are undertaken.
In addition, for new participants in the industry, it will be difficult to get a rating until they successfully undertake a number of projects. This may act as a barrier to entry for new participants, which will have various commercial consequences to the industry.
Although, on the face of it, the new regime should be good news for purchasers, there are some significant possible adverse consequences as well. These are:
Delays in getting to settlement
- To the extent a Stop Order is issued or an occupation certificate is not issued in relation to a project, a purchaser will suffer potentially large delays in completing its purchase. Indeed, settlement may not occur at all if the relevant issues cannot be addressed. This is likely to have adverse flow-on effects in relation to the purchaser’s financing as well as the sale of its current residence.
Increased difficulty in getting finance
- The purchaser’s financiers may require a new valuation (which may prove to be less than the original valuation obtained thereby reducing the amount of the loan it will provide) or withdraw from the financing altogether due to the delay or its concerns in relation to the building.
Impact on sale of existing property
- To the extent a purchaser has entered into a contract to sell an existing property to fund the purchase of its new apartment, he/she will need to consider whether the delay in completing the purchase of the new apartment will allow the purchaser of the existing property to rescind their contract.
Refund of deposit may not cover all losses
- Although a purchaser may receive his/her deposit from the developer of a project which is no longer proceeding or is extensively delayed due to the issue of a Stop Order or failure to obtain an occupation certificate, this may not be sufficient to cover the loss the purchaser will incur see above.
Financiers will also be subject to various business challenges arising from the proposed new regime. These include:
Increased potential for losses
- To the extent they have financed a project which is not completed by the time the new regime comes into effect, they face the risk that the off the plan purchasers will be entitled to rescind their contracts due to the issue of a Stop Order or the failure of the developer to obtain an occupation certificate.
- The value of projects suffering the above consequences will decrease and their future marketability will be difficult. This may lead to greater losses for the financier involved.
Increased competition for good borrowers
- A greater number of financiers (both bank and non-bank lenders) are likely to limit the developers and design and building practitioners they wish to deal with to those with a good track records, who are fully compliant with the new regime and are attributed a good quality rating under the new regime. This may lead to consolidation in the development sector as well as the non-bank lending sector and change the types of residential projects financiers are prepared to finance.
Need to reassess due diligence processes and documentation
- Financiers will need to review their credit criteria, the scope of their developer borrower due diligence and their standard documents to account for the new regime.
It is clear that the new regime for the building and development sectors in NSW, once adopted, will have a major impact on everyone involved in the development sector. Given the potential negative consequences of the regime, it will be interesting to see how the NSW government manages the reform process to minimise such consequences.
We trust you enjoyed this Alert.
Please feel free to contact us about our fixed fee initial term sheet review (FFITR) service which will assist you in minimising the risks associated with signing initial or indicative finance term sheets without really knowing what is in, or is missing from, them.
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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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