The last 12 to 18 months has been a dramatic ride for Developers large and small across the world but also in Australia, and more so than many people on the street might think.

Most of the large listed Developers are finally taking a gasp of fresh air with a feeling of incredible relief after intense activity to recapitalise their companies and having come dangerously close to breaching existing loan covenants, many selling assets, massively shrunken share prices, and needing to refinance maturing short term debts in the face of the tightest credit in their histories.

Small to mid-size Developers have either come out nicely due to the stage their projects were at, or gone to the wall if they were over-geared, had a no better than normal level of pre-sales or pre-leasing, or were relying on finance companies or structures that couldn’t stand any heat.

Private investors and some institutional ones that have been cashed-up for a while or conservatively geared, have recognised the opportunities that any recession or pull-back offers, and jumped on the bargains.

In Australia it only seems like the Global Financial Crisis (GFC) has been with us a year or so. To Americans it may seem a bit longer but most people are surprised when I show them the following chart where the level of new home building in the US actually started crashing in September 2005, some four years ago! And look how similar this downturn is to the one commencing in December of 1972.

We have all heard endlessly now about the property and finance bubble in the US and elsewhere, and about the irresponsible lending, the Wall Street finance derivatives that powered it all, Chinese and Indian capital that flooded into the US and supported consumer spending and housing expansion, and about the 20, 30 and 40% house price crashes in the US and UK. Australia has been lucky in this regard although a few economists have been predicting the same fate for us.

Although the number of house sales dropped off quite a lot here, despite a small backward move now mostly recovered, we (fingers crossed) have escaped house value declines. Will this continue to be the case given that house prices here in comparison with household incomes (ie affordability) are amongst the highest in the world? Most Developers and Economists seem to believe that we have been saved by strong pent-up demand from under-building over recent years, high immigration, quick RBA action lowering interest rates, Government stimulus particularly with the FHOS, the strong fiscal position left by the previous Government, and now the fortuitous and timely need for big infrastructure spending.

But where to from here?

Commercial Developers (including commercial office, industrial and retail) are dealing with softened ‘Cap’ rates that lower project values, reduced demand due to the GFC, office vacancy rates that in 12 months have gone from the tightest ever (ie <1% in Brisbane’s CBD and fringe to likely over 12% next year) due to the GFC and excess ‘supply’ that was committed prior to the GFC. Rents are also on a precipice but just holding for the time being despite there being a ‘tenants market’. Soft Cap rates and reducing rents are a horrible crunch on project values for commercial Developers. New projects are mainly happening because of either very specific tenant needs or Developers prepared to take a bit of a bath on the value of land they put into projects. I have heard talk in the US about the possibility of a double dip recession led by a crisis in commercial real estate for the reasons just mentioned.

Residential Developers are watching what happens with first home owners and the follow-on effects, hoping that prices continue to hold or grow, and that consumer confidence returns (and unemployment doesn’t get too bad) so that pent up demand is released. Statutory Planning issues are big at the moment. Local Authorities are holding back land to protect the environment and increase density of existing urban areas. This is great for the efficiency of infrastructure but Council’s and Government still want their pound of flesh, and consumers aren’t sure they want it unless it comes with a great deal of existing amenity. Affordability limits and uncertainty about pre-sales could be a dampener, along with development finance continuing to be a challenge for all size Developers.

Most Developers are looking to smaller projects or smaller stages within existing projects to reduce financial exposure.

Best seat in the current situation goes to Developers that have held land for some time or bought cheaply, can proceed with substantial equity (low gearing) and a good relationship with a strong bank or financier, and in locations with proven fundamentals.

But like all things, in Development the big risks come from not knowing what you are doing or failing to plan for what you are doing!

All the best in Development …

Written by: Paul Evrat