Australia: Issues for inbound Asian based property developers to consider
Given the influx of Asian based property developers entering into the Australian property market, particularly the residential sector, there are a number of critical aspects associated with Australian property development to which developers must be across before proceeding.
Key issues to be aware of for those involved in proposed acquisitions and developments include:
- Environmental considerations
- Project feasibility
- Market acceptability
- Australian financier requirements.
Key issues for offshore developers to consider before entering the Australian marketplace
Developers must take into account the suitability of the proposed development site from a contamination point of view. If the property contains contamination from previous uses, such as industrial or service stations, approval authorities require the property to be decontaminated to an approved standard. Where the intended use is residential, authorities may require a Certificate of Environmental Audit to be issued. The costs of clean up or decontamination can be considerable and must be properly factored into the project feasibility.
Proposed acquisition sites are generally limited to two types:
- Where the proposed development site, whether broadacre or inner city, already has the benefit of an issued planning permit
- Where no planning permit has issued for the property.
The planning and design process in the Australian development market is heavily regulated and can be the subject of time delays in proving up a design and a feasibility so as to comply with all regulatory requirements.
The relevant planning authorities, which include state government and local councils, have very restrictive guidelines on height, density, set back, overshadowing (e.g. Yarra River) and communal design, so as to limit the impact of the design on the community.
There are however certain designated areas, such as activity centres, under which the design guidelines have been relaxed to promote higher density including greater height of projects, as distinct from medium to low rise infill developments. The Government encourages higher density projects in these nominated activity centres, whereas there are very strict prohibitions against excessive height or excessively bulky developments in non-activity centres. Intending developers must bear the zoning aspects in mind as there will be substantial delays incurred in obtaining development approval.
At Maddocks, we are aware of a number of instances where offshore developers have acquired sites with the expectation they will be able to obtain planning approval for their developments which have not eventuated, or have been substantially scaled back to comply with the planning requirements which reduces both the number of apartments able to be constructed, project revenue and profitability.
We recommend that before any development site is acquired, preliminary advice should be taken from planning consultants and/or legal advisors on the extent to which the relevant planning schemes permit the construction of the type of development which the developers would like to make on the particular site. As a result, we recommend, if there is competition amongst developers for a particular site, that at least a limited due diligence period of a minimum of one week be entered into as distinct from an unconditional contract to purchase.
Development sites with planning approvals
There are a number of instances where keen developers have secured a site, have gone through the design and development phase to procure a planning permit and then, for various reasons, have decided to on-sell the development site to other developers who have greater resources to carry out the development. Whilst this has a substantial benefit developers pay a premium for such a site and in various instances, the approved design may not be the most efficient or the best use of the development site due to the fact it may have been scaled back to comply with regulatory approvals. The consequence being a lesser return to what developers may initially have hoped.
Maddocks recommends that careful consideration be given to the conditions of approval and the associated plans for the development to ensure they optimise the best use of potential of the property. Consideration needs to be given to the existing contractual documentation surrounding the development which may impact on a developer.
The Australian residential market is divided into two aspects:
- Investor stock
- Owner occupied.
Both of these sectors have substantially different requirements for design, quality of fitout, area of apartment and communal facilities.
We have noticed in certain areas, particularly in inner suburban infill developments, there has been a substantial demographic shift from investor stock to high-end quality, owner occupied apartments which have substantially different design requirements and expectations from intending purchasers. Quite often, the apartments are much larger, such as two bedrooms plus a study with two bathrooms. Communal facilities on the upper level are becoming the standard, rather than penthouses.
Maddocks has considerable experience and expertise in dealing with the legal aspects of development which creates a higher return to the developer but requires much more substantial design and development work to be carried out.
Australian financial market
The choice of suitable Australian based financiers to undertake speculative residential and commercial property development at the higher end of the spectrum, (e.g. above A$50 million) is substantially restricted to the four major Australian banks being Commonwealth Bank of Australia, Australia and New Zealand Banking Group Limited, National Australia Bank and Westpac Banking Corporation.
Each of these banks have fairly stringent requirements on their risk assessment of projects so as to ensure they are not susceptible to incurring potential exposure if the current strength and resilience of the residential property market becomes the subject of a sustained property downturn.
To our knowledge, the requirements of Asian based financial institutions, as compared to Australian based financial institutions, are different given the fact many Asian developments are backed by the balance sheet strength of their parental group, whereas, most Australian non-listed property developers have a much more restrictive balance sheet and therefore will require much higher finance gearing ratios. This means each project becomes a more specific project structured finance transaction under which the financier's risk is heightened and more concentrated around settlement risk and the exit strategy out of receipt of sale proceeds and the limited recourse against the project sponsors in the event of a shortfall occurring.
Australian financial institutions have fairly similar but relatively strict requirements on the carrying out and financing of residential apartment developments.
As a consequence, if developers are considering seeking finance from an Australian financier, they must be aware of the following issues:
- The financial resources of the project sponsors
- Their experience in carrying out residential developments in Australia and their ability to bring projects to a successful completion
- Environmental issues
- The quality of the pre-sale contracts
- The financial capacity and the experience of the proposed builder to complete a project on time and on budget.
Conditions precedent to funding
As a consequence of these key requirements, developers will often be faced with a considerable number of conditions precedent before funding can commence which expand upon these requirements and can often add up to 40 conditions precedent to be met.
The most expansive and important pre-sale requirement of financiers relates to the level of 'qualifying pre-sale contracts'. Financiers usually require developers to hold qualifying pre-sale contracts, net of GST and agent commission to equal the amount of the intended facility.
Financier facility agreements contain a considerable number of requirements as to what constitutes a qualifying pre-sale contract as not all contracts are deemed by financial institutions to be qualifying.
The key requirements can be summarised as follows:
- The compatibility of the marketing campaign, marketing information, brochures and pictorial as against the final approved design
- The pro-forma contract of sale has been certified to comply with all relevant Australian legislation
- An external audit of the pre-sale contracts is carried out by their financier's solicitors
- Provision of a borrower's solicitor's pre-sale opinion confirming all qualifying pre-sales contracts are fully valid, binding and enforceable against the purchasers
- Certification that there are no side agreements, rebates, discounts or incentives which have not been disclosed
- Where sales to foreigners are contemplated, FIRB approval is obtained, and the level of sales to foreign purchasers does not exceed an agreed threshold which may be in the order of 20 to 30 percent of all pre-sales
- All pre-sales contracts are arm's length e.g. no related party sales
- Purchasers are not permitted to acquire more than two lots
- Contract price is equal to or no less than 95 percent of recent valuation
- Apartments must have a minimum habitable area, which is currently 40m2 and which is shortly to be increased
- Contains a sunset date on the registration of plan of subdivision with a minimum of six months after the date of practical completion
- Contains the ability of the vendor to assign and mortgage the sale contract to a financier
- Provides for a deposit of no more than 10 percent of the purchase price due to statutory restrictions
- Where a bank guarantee is provided as evidence of a deposit, the bank guarantee does not have a sunset or expiry date less than six months after the date of practical completion
- The designs, plans and specifications of the development must be consistent upon the building contract, marketing materials (written and pictorial), the valuation and the quantity surveyor report
- The purchaser does not have the right to terminate the contract
- Where a corporate purchaser enters into a contract where the directors have provided a personal guarantee.
Please note the above list is not exhaustive and depends upon the circumstances. The financier may require a greater number of requirements.
Non-qualifying pre-sale contracts which do not meet these strict requirements are not considered in calculating the level of qualifying pre-sales which is usually set at 100 percent of the facility limit net of GST, deferred agent's commission, incentives rebates and discounts and settlement costs.
From our experience, it is often the ability of a developer to achieve the required level of qualifying pre-sales that is the greatest hurdle which developers must meet before construction finance can commence.
Delays in achieving all of the requirements and satisfaction of conditions precedent will have a knock on effect to the timing of undertaking the developments which impact upon the sunset date for the registration of the plan of subdivision.
In order to ensure a development proceeds in accordance with the proposed timetable, it is our experience that developers should seek legal advice before entering into a development project. This ensures all of the issues set out in this eAlert can be adequately addressed and contingency plans made to comply with the development timetable, which leads to more certainty to the anticipated profitability of the project.
Maddocks has considerable expertise and capability to assist in all of these areas from beginning to the end of residential projects.
In a future e-Alert we will explore a number of additional issues that need to be considered by Asian based property developers. In particular, we will explore some of the risks and potential pitfalls facing developers in the Australian market arising out of various pieces of consumer-focused legislation relating to residential building work, and various pieces of construction-industry payment legislation which will dictate many critical aspects of the contractual relationship between a developer and a construction contractor (and design consultants).
For more information, please contact:
+61 3 9258 3689
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