04/11/2022

DEVELOPMENT SITES A CATCH 22 DILEMMA BUT NOT FOR EVERYONE

The development site space is the most talked about sector in our market at the moment. With development margins either being squeezed or non-existent, the conundrum that a project has strong underlying demand for the end product, but the financial viability of the project simply doesn’t stack-up is a common narrative. The result of this is downward pressure on site values as developers look to offset project costs with no short to medium-term relief in sight regarding the cost of financing and construction.  

Developers are looking for price softening to offset their risk-adjusted returns and project delivery challenges. There is a flight-to-quality approach when assessing sites, with well-located sites with existing development approvals where high demand for the end product are preferred. Developers are looking for adaptive sectors or submarkets where there is strong tenant or buyer demand for the product they are building. We see that residential sites for build-to-sell, build-to-rent, student accommodation and senior living are highly sought after. Well-located retail and industrial sites also continue to be in high demand. We have also seen a number of traditional developers pivoting to more value add opportunities by acquiring existing buildings to refurbish, repurpose or build additional floor areas where possible.

With construction and finance cost blowouts we are seeing a number of institutional groups divesting assets in order to redeploy capital into existing development projects, instead of taking on more project debt. For developers sitting on sites, putting the site in the freezer and bringing it out to defrost in one or two years’ time only works for a small portion of the market. If there is no income to cover the holding costs, the project returns will be quickly eroded.    

A large portion of developers are sitting on the sidelines to see what takes shape in 2023, with the expectation that development site pricing will soften. Nevertheless, we have seen continued transaction activity for CBD and CBD Fringe sites, in particular those which are nearby major infrastructure and Olympic venues.

The underlying issues of labour and material shortages, weaker dollar making imported material and goods more expensive, and increasing finance costs cannot be ignored. There are many moving parts to the puzzle and there is no one solution that works. By the time a developer acquires a site, conducts due diligence, settles then obtains development approval, we could potentially be in a different cycle where the project is financially more viable.

It’s hard to see when the rebalancing of the market will happen. By the time it does rebalance, the ship may have already sailed, and the competition to acquire sites will be immense. There is still a significant level of demand and transaction activity, and when Australia’s largest apartment developer is rumoured to be acquiring a significant CBD site, we know the outlook is promising.