REAL ESTATE INVESTMENT ALERT
2020 – DO YOU HAVE PERFECT VISION FOR THE YEAR AHEAD?
2020 is shaping up to be a good year for property investors and developers as well as their financiers.
The doom and gloom of the last 12 to 18 months have been replaced by:
- increasing prices and positivity in relation to future prices in most property markets in Australia,
- experts predicting a shortfall in the supply of apartments relative to demand to start happening in about 18 months,
- an increasing number of developers undertaking build to rent projects,
- expectations of further interest rate cuts, and
- a continuing appetite for property investors to get involved in lending in addition to their core activities, resulting in even more sources of property finance being available to property investors and developers.
In this environment investors and developers will no doubt start considering their plans for the year ahead.
In this Alert, we touch on a number of matters which investors and developers need to consider to ensure that they go forward in 2020 with their eyes wide open. It is important not to get too caught up in the good news and think that new projects can be undertaken in the same way as in the past.
Times are changing and investors and developers need to account for these changes to make sure they don’t get burnt as they may have in the past.
In this edition of our Real Estate Investment Alert we highlight:
- Some market trends which will impact on future projects
- The changing regulatory environment and what this means
- Some useful tips on how to improve a borrower’s finance outcomes.
SOME MARKET TRENDS WHICH WILL IMPACT ON FUTURE PROJECTS
The Opal and Mascot Towers situations (as well as the cladding issue) has had a significant impact on buyer appetite for high rise residential developments. The lack of buyer confidence in these types of developments has had a number of flow-on effects, including:
- demand for apartments in such developments dropping significantly with consequent drops in prices,
- owners of such apartments losing some or all of their equity,
- some developers abandoning development plans and losing their equity in projects,
- a number of mortgagee sales or receiver appointments having occurred in respect of high-rise development projects,
- financiers (particularly banks) being hesitant to fund these types of developments, and
- the likelihood of future developments of this nature being dominated by top tier developers with an impeccable reputation and track records.
These factors have placed residential developers under pressure and have highlighted the risks involved in these types of projects.
More broadly, the impact of online retail has had, and continues to have:
- a significant adverse effect on retail properties, with a number of the large developers selling retail assets over the course of this year, and
- a positive effect on industrial property.
The ongoing affordability crisis for first home buyers, the possible benefits to retirees in realising the equity in their homes and the very low interest rate environment is leading to greater interest in the build-to-rent sector.
Given the above, in our view property investors and developers are likely to focus on the following types of properties over the next 12 months:
- low to medium-rise residential developments (often high end so as to attract baby boomer downsizers),
- industrial projects, including strata industrial units,
- build-to-rent projects, although these may be dominated by top tier developers, and
- commercial office buildings.
The ability to get finance has always been dependent on (amongst other things) the nature and location of the project, the quality and track record of the developer and builder (and the individuals backing them) and the market for the finished product.
Given where the market has been over the last 12 – 18 months, investors and developers will need to be more selective as to the projects they wish to undertake in order to maximise their ability to obtain funding and minimise the recurrence of the adverse outcomes that some developers have had to endure over that period.
THE CHANGING REGULATORY ENVIRONMENT AND WHAT THIS MEANS
In addition to the above-market factors, a large number of regulatory changes will come into effect over the next 12 – 24 months.
We have discussed a number of these in our previous 2019 Alerts. These include:
- the outcomes of the Shergold Weir Report “Building Confidence” – see our February 2019 Alert and August 2019 Alert, and
- the increased circumstances in which off-the-plan purchasers in New South Wales will be entitled to rescind their contracts – see our September 2019 Alert.
Unfortunately, these changes will result in additional costs being incurred by developers, particularly in respect of high-rise residential developments. The uncertainty as to the timing and nature of a number of these changes will also place additional pressure on developers and potentially make it harder to undertake these types of developments.
We are already seeing substantial increases in professional indemnity insurance costs for engineers which are likely to be passed onto their clients.
For the above reasons, developers 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 their projects to account for the changes as efficiently as possible
- factor the costs of the changes into their feasibilities/project budgets,
- can adjust their processes to be compliant with the new rules once they take effect, and
- can 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.
SOME USEFUL TIPS ON HOW TO IMPROVE A BORROWER’S FINANCE OUTCOMES
As mentioned above, one of the consequences of the markets over the last 18 -24 months has been the rapid growth in the number of non-bank lenders in the property and development finance space.
The view seems to be that the number of non-bank lenders will only increase, given their proportion of the commercial and development property finance markets in other jurisdictions, particularly the US and the UK.
Due diligence on the lender
As with any market with a large number of participants, not all non-bank lenders are the same. Due to the different sources from which their funds originate (both in the nature and location of the funding source), investors and developers need to do due diligence on any non-bank lender they wish to deal with. This is to ensure that the lender will have the funds available when required during the project and does not have onerous or harsh terms in its documents.
The financial impact of non-financial terms
Although the main financial terms are generally disclosed by the lender upfront, non-financial terms are only disclosed in the more detailed term sheet and formal loan documents which are provided closer settlement.
As there are a large number of non-financial terms which can have significant financial and commercial consequences to a borrower, receiving and understanding these terms at such a late stage in a project will generally result in little or no opportunity to negotiate changes.
Restrictions on prepayment
A number of non-bank lenders (predominantly offshore institutions) offer long term, fixed-rate finance for investors acquiring substantial income-producing properties. One matter which is of relevance to all borrowers, and particularly to investors considering such funding, is whether there are any restrictions on prepaying all or any of the loan. These may take the form of minimum interest requirements, an absolute prohibition or the absence of any right to prepay.
As is the case with any other fundamental elements of a project, getting advice on all of the main terms of finance documents (not just the financial terms) as soon as possible in respect of a proposed project is very important.
As mentioned by ASIC recently, albeit in a different context, failure to know what non-financial terms will apply will result in “very real financial implications for companies, and their investors”.
Effective oversight and management is important
As also mentioned by ASIC, “effective oversight and management of non-financial risk are not novel or impossible”. Getting advice on these issues as soon as possible and prior to accepting any term sheet or offer of finance is a key risk mitigant.
See our 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
We trust you enjoyed this Alert. Please feel free to contact us about any matter mentioned above, including details of our fixed fee initial term sheet review service which will assist you in minimising the risks mentioned above.
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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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