Open up any newspaper these days and the commentary around the property market reads: “housing bubble”, “apartment oversupply” and “housing market collapse”. You may well think that one of the biggest sources of wealth in this country is about to come tumbling down like the proverbial house of cards. Sensationalist or an accurate prediction? Deloitte Real Estate recently held discussions with a number of prominent Western Sydney developers who shared their insights on the current residential apartment market, which help cut through the noise in the headlines and provide an informed perspective on what is actually happening. Is Sydney affordable for first home buyers? The Western Sydney region offers affordable housing choices for first home buyers. Affordability is an issue as Sydney has experienced unprecedented growth in dwelling prices in recent years. Developers were well aware that first home buyers would be geographically pushed further out in a west or south-west direction to the outskirts of Sydney metropolitan areas where dwellings were more affordable. Prices have risen, particularly for apartments in major centres like Parramatta, with great connectivity and access to jobs, and for house and land packages where supply remains lower. However, in absolute terms, property in Western Sydney remains more affordable than inner Sydney and the market should continue to require developers to create affordable projects while balancing higher land prices and construction costs. Is there an oversupply of new residential apartments in Western Sydney? The answer depends on which part of Western Sydney but ‘oversupply’ may be an overstatement. Most news articles talk of a ‘potential’ oversupply as they are based on building approval statistics. It is a fallacy to directly correlate building approval data with oversupply, as it assumes all building approvals will commence when this is not the case. Sydney is made up of sub-markets, each with their individual supply and demand drivers and characteristics (for example, one such driver is connectivity and access to transport). Developers adjust the delivery of their new apartment project pipeline based on their market confidence in the sub-markets of Sydney. In Western Sydney, the concentration of new apartment development is naturally occurring in the city centres of Parramatta, Blacktown and Liverpool, with the uptake of many infrastructure projects driving demand. An oversupply of apartments would show signs of builder stress, price discounting and other incentives, however, anecdotally, this is not occurring. Projects generally wouldn’t have been able to commence construction without having pre-sold apartments to the same value as the bank debt required for the project, typically at least 50% to 70% of the apartments in the project. Therefore, the available ‘supply’ that remains unsold on most projects commencing would likely be 30% to 50% of apartments which is not such a dire situation. The intention of developers can change from building and selling to building and holding. The ‘build and hold’ approach delivers rental returns and a saving on costs forgone such as the selling agent’s fees and GST on the sale (total cost savings of approximately 10% to 12% per unit). Other developers have gone further and leased apartments on a furnished basis (generally units in main city centres). Even based on this approach, an oversupply of apartments would not appear to be an issue as developers are in control of their availability. Is there potential for a correction in Western Sydney apartment prices? Our overall view is that it is unlikely; however, we have to consider this question at a granular level. New and off-plan sales activity within the broader Sydney residential apartment market is currently yielding mixed results across suburbs. Those suburbs offering higher amenity and transport links combined with limited supply are outperforming. In contrast, some suburbs are facing a temporary over-supply resulting in a slowdown of sales activity. This situation may lead to developers offering incentives (e.g. cashbacks, furniture packages, stamp duty rebates) to invigorate selling activity. Price reductions would be considered by a developer in desperate times and generally as a last resort. Such a measure diminishes the value of all previous stock sold in the building and could tarnish the developer’s reputation. We are yet to see evidence of price discounting in the Western Sydney apartment market. It is currently a fluid market and there are counterforces at play supporting price stability, including further reductions to interest rates and an under-supply in particular sub-markets. Are apartments that are purchased off-plan ‘getting over the line’ at the time of settlement? Off-plan units purchased in the past 6 to 12 months are at the highest risk of delayed or non-settlements – developers need to keep a close eye on this group of purchasers. Simply put, off-plan sales need to settle to clear the bank’s debts and generate a profit for the developer. Risk of settlement is a risk to a project’s viability. Settlement risks have heightened in the current market as financiers changed lending parameters for residential property investors in the past 6 to 12 months through reduced loan to value ratios and higher interest rates applicable to investment loans. Off-plan apartment sales are currently the investment of choice for foreign buyers. Media reports on the percentage of off-plan sales going to foreign buyers are mixed. We consider foreign buyers to be contributing materially to the volume of off-plan sales and in specific geographical areas (for example, Parramatta, Chatswood and Burwood). Projects sold with a high level of foreign buyers may be exposed to additional settlement risks as international factors could influence the ability of the foreign buyers to settle, as well as specific local measures (e.g. additional stamp duty) affecting this group. The financiers will be monitoring settlements very closely to mitigate their own risk and should also be looking closely at how actively the developers manage settlement risk. Developers need to manage these risks by remaining in contact with pre-sale purchasers during the construction phase and check their financial ability to settle on completion. Have the banks ‘turned off the tap’ to developers? Bank funding has been tightened and the tap has gone from a stream to a trickle. The Big 4 banks have adjusted their appetite for property development lending (just ask any residential property developer). These actions have been in response to heightened market risks and regulatory pressures. The major banks remain active in property development lending but only on a selective basis and at reduced exposures. It is virtually impossible for inexperienced developers to obtain bank funding and even experienced developers are finding it hard to increase their facility limits. These actions taken by the Big 4 banks have left a gap in the property development lending market and alternate sources of funding are now filling the gap. Opportunity for overseas and private funders have emerged and continues to build momentum. What ‘pain points’ are builders currently feeling? Contract builder profits are under pressure as they are ‘squeezed’ between higher trade prices and a competitive tendering environment. Rising trade prices are resulting in increased project costs. This creates an increasingly competitive and challenging tendering environment for contract builders. Situations where the head contract price has been locked-in and trade prices have not, potentially expose the builder to financial losses through price creep. If these and other similar risks are not mitigated then builder distress will likely eventuate. Builders at higher risk of distress include those that have undergone significant and rapid growth over a short time period, as they have newer teams with limited experience operating on a larger scale. These type of builders typically emerge while approaching the peak of a construction market cycle and are highly susceptible to even a moderate downturn. Typical signs of builder distress include decreased tradesman activity on-site, increasing recurrence of over-claiming and a high turnover of site management staff – just to name a few. Anecdotally, we’ve heard of an increased trend in these matters being referred to lawyers for negotiated settlement. With anticipated population growth and strong market fundamentals, the medium-term outlook for residential developers in the Western Sydney region is promising.