Development – Adversarial by Nature or Choice?

I have a background as a litigation lawyer. I can honestly say that the bulk of the legal profession was courteous and supportive compared to the inherent conflict I have experienced at almost every level of the property, development and construction industry. This is even more incongruous when I factor in the symbiotic nature of the property eco-system compared to the relatively independent business models of the legal profession.

Let me illustrate my point by examining the evolution of a property development:

1. Acquisition of a site – The vendor wants to get the highest price; the purchaser wants to pay the least possible. If there are multiple buyers, they are pitted against each other by the vendor and its representatives. All healthy competition (unless you want to make the end product affordable), noting that the land component will be 15-25% of your development cost.

2. Schematic design – at this point, various consultants are engaged with the focus on yield and planning. Architects, engineers, planners, quantity surveyors and, on occasion, builders are all asked to provide services at discounted rates with the promise of a job if all stacks up. Relationships are formed only to be subsequently exorcised by the inevitability of D & C Contracts and Novation.

3. Feasibility – the elements are consistent:

• Revenue less GST (if applicable)

• Land Cost
• Construction Cost
• Consultants
• Authority fees
• Finance Costs
  
  

Development profits or Rates of Return calculations determine viability. Ideally 18% plus IRR is achieved but this has been very rare in the last few years, leading to stalled projects, insolvencies, extended holding costs, cascading acrimony and frustrations.

4. Planning – after the first 3 steps we have sufficient belief in our project so let’s get a Permit. Best case scenario: 8-12 months; worst case scenario: infinity and beyond. Cost is immeasurable. Objections are often bizarre and driven by self-interest or delusion. Process roadblocks can and most likely will include local authorities, statutory authorities, Cultural Heritage Reporting, VCAT, ESG compliance or Affordable Housing requirements.

5. Marketing – pricing your product to meet the expectations of owner-occupiers, investors and affordable owners/renters is an art form. Pre-sales involve the engagement of agents and channels both of whom require material commissions years before any revenue is accessible to the developer. The traditional display suite combined with visual material and social media marketing is a seriously expensive exercise.

6. Finance – sourcing debt from traditional banks has become a mythical exercise for many developers. A plethora of alternate funders at double the cost of the traditional banks have accordingly evolved. “Relationships” were created in this space but in recent times shopping around has become necessary and is often encouraged.

Sourcing equity has become extremely difficult in view of the returns available to investors from traditional 65% LVR property-secured debt. Self-managed, externally managed and jointly managed “opportunity funds” have sprouted, seeking to capture investors with higher risk appetites. These opportunities generate higher returns but require independent investment committee risk assessment and are ripe with potential conflict.

7. Construction – engaging a builder is currently my definition of “inherent conflict”. That includes:

• Tendering – clearly intended to achieve a win/lose, lose/win or lose/lose relationship.
• Design and Construct contracts expressly granting a “value management” right to a builder which has been obliged to accept a profit margin no other business would contemplate.
• Novation which severs voluntary creative relationships and imposes servile largely forced relationships.
• Risk allocation which historically imposes on the builder numerous risks including latent conditions, weather, supply chain costs and delays which were previously the concern of the Developer.
• Tri-partite arrangements which create a further hierarchy with a financier imposed on the builder.
• Unions –EBAs need to be re-assessed for their impact on affordability and productivity.

Yet property development is a symbiotic eco-system where everyone wins if everyone is successful, and everyone loses if anyone fails. One developer, subcontractor, builder or financier failure has the potential to ripple through the industry.

Confidence and trust are vital to success and public perception is fragile. Interest rate stories move markets despite the fact that they seem to have peaked at about 50% of what they were at some point decades ago. Cladding and apartment defect stories impact sales as do unfair strata management agreements. Investors seeking rental returns barely covering levies, land tax and interest costs have become pariahs and are fleeing markets. Foreign investors who largely enabled most of our large-density projects have become evil personified and have been largely eliminated from the market by discriminatory taxation regimes.

The development eco-system has the levers to mitigate conflict and choose different paths. If we want to create affordable products and permit the industry to recover and bloom, the answer had better be at least partially supportive. The path requires collaboration, goodwill and, like all realistic business plans, self-interest. Here are some ideas:

1.  Acquisition of a site –

• Taxation and planning reform such as stamp duty regime substituted for land tax paid annually and removal of general public objection rights would encourage acquisition.
• Public/Private partnerships with government-contributing land with long-term reversion rights should be explored.
• Not for Profits that have vast land holdings should be incentivised and commercially supported with appropriate expertise to make those sites available for appropriate and synergistic development. 
• Adaptive use of existing sites and structures should be incentivised.

2. Schematic design –

• Planning permit conditions should require retention of the initial consultancy team unless impractical or inappropriate (this does already occur on larger projects with respect to Architects)
• Fee structures need to be weighted towards design as mechanical tasks such as the creation of working drawings increasingly fall to overseas facilitators and AI.
• Sub-contractor agreements should not silence consultants who should have a legislated duty to care for purchasers and owners corporations.
• Government-supported insurance cover should be available assuming builds are in accordance with design and permit.
• Post acquisition, feasibility and planning but prior to signing a D& C Contract, Design should be at 70% or more – at that point a value management process is meaningful without impacting quality excessively.

3. Feasibility – 

Property development directly and indirectly generates a large portion of Government revenue. It creates employment and vital infrastructure. Allowing for reasonable risk, no commercial development project should be progressed with a feasibility study expressing a 15% plus IRR. If the eco-system addresses requisite reforms this can be comfortably achieved.

4. Planning – to make it predictable, economical and expedited:

• Reduce Council involvement in reviewing a submission if sufficiently relevant and impactful.
• Only allow public objection processes in limited circumstances and equitably address obstructions. 
• Create an appropriate structure with a mix of skilled and experienced personnel representing all sides of the eco-system to oversee the creation of structure plans, approve larger scale projects and a regimen that allows smaller scale projects subject to meeting pre-set criteria
• Use planning as an incentivisation tool for ESG, Affordable Housing, Adaptive and like policies.
• Introduce Planning to “common sense” by allowing flexibility on Building Apartment Design schemes to enable affordability and introduce customised planning and building codes for affordable BTR schemes. Do not insist on uncommercial “activation” at podium levels.
  
  

5. Marketing –

• Introduce legislation and monitoring to require transparency and ethical behaviours in the sale process, contractual terms and conditions and ideally provide insurance options for non-delivery, deception or subsequent defects.
• Demand is at record levels – create product and pricing (supply) to meet demand.
• Factor strata title fees into pricing and address quality of lifestyle issues such as short-term leasing rules.
  
  

6. Finance – 

• Developers need to access Superfund finance and not indirectly through Alternate Financiers which introduces a further fee structure.
• Appropriate developments should have the ability to access social impact bonds with Government, corporate and private investment support.
• A nuanced access to superannuation funds to acquire a residential home should be permitted.
• Bank home loan ratios should be reviewed with appropriate independent financial education for borrowers to be accessible if not mandated.
• Continuous development of innovative but equitable finance offerings to informed purchasers.

7. Construction – 

• Earlier engagement with the builder – ideally substituting the competitive tender process with a relationship model.
• Insistence on design achieving 70% before any value management initiatives.
• Accepted a fair builder’s margin (7-12% depending on size of job), allowing a fair contingency and open book preliminary and trade costing.
• A fair allocation of risk relating to latent conditions, weather, supply constraints and force majeure.
• Realistic builder guarantees, retention and damages clauses which do not elicit continuous extension of time and variation claims.
• Joint venture and framework models allowing builders and developers to create pipelines which in turn allows for managing resources, cost savings and profit sharing.
  
  

I am fully aware of the ambition of some of these proposals but I am equally certain that they need to be considered - not just individually but holistically. Over 3,000 builders failing, affordable housing now a myth and rentals not only becoming the norm but not being built should be enough to convince. The industry is full of clever people bursting with goodwill and better ideas. The world has numerous examples we can learn from – study the Scandinavian countries, Singapore and the Middle East. BTR, land lease communities, and student accommodation were all models done overseas well before we discovered them. Remove the politics and, with the intellectual capacity and resources in Australia, material improvement is realistic – we owe it to the next generation.

Author - Benni Aroni, Client Director Property, Pitcher Partners & Board Member, Hickory Constructions