Melbourne is shucking off the doldrums as higher borrowing capacity, a lower cost of construction and increased builder capacity create the perfect recipe for a boom.
The seemingly never-ending cycle of working and reworking feasibilities may be coming to an end as the market improves, and there is a serious amount of private capital looking for a home, according to MaxCap’s Bill McWilliams.
“There’s more capital that’s flowed into private credit than there are cranes in the sky—that’s the reality of it,” McWilliams said.
“It’s changed quite quickly. Five years ago there wasn’t really a private credit market to invest into. The strong risk adjusted returns has resulted in a significant amount of capital that’s flowed into private credit at a time when construction starts are below long-term trends.”
Speaking at The Urban Developer’s industry leaders lunch in partnership with MaxCap, McWilliams said the Garden City could be in line for a turnaround as feasibilities improve.
“Feasibilities are improving but they are still hard, so you need to be very sophisticated when you structure your debt to ensure you do it in the most efficient way.
“And that’s why there’s strong demand for non-bank debt. The banks have come back aggressively in relation to pricing, but that doesn’t necessarily mean bank debt is the most efficient way for a developer to optimise their return on equity.”
But McWilliams said it was a good time to be a developer if you were shopping for debt.
“Your capital stack is still really important though in terms of how you’re getting to financial close. For example, a flexible debt solution can result in construction commencing earlier, and less upfront equity for developers,” he said.
“Even though you know that there’s a debt solution in the market today, not all debt is the same.”
Samuel Property managing director Illan Samuel launched HALI at Dromana earlier this year and construction is well under way on Louise, an apartment tower in the enviable position wedged between Fawkner Park and Albert Park.
Both projects are of a scale he is looking to fill his future pipeline with. And while the post-Covid era hasn’t been without its challenges, the developer is confident in getting the revenues he is chasing.
For Samuel the risk has always been the unknown hurdles, but he said he believed that conditions were stabilising.
“People are getting more comfortable within their feasibilities now, particularly with so many of the volatile inputs of the post-Covid era now stabilising,” he said.
“Developers should now be well-positioned to make forecasts with respect to planning permit timeframes, construction costs and sales rates and do so, with far more certainty,” he said.
“Ultimately, as the industry stabilises, developers should not be facing significant blowout in timings and costs.”
While construction costs are still elevated, house construction input prices recorded their first quarterly price contraction since March of 2012, according to the Australian Bureau of Statistics.
Steel products dipped 1.8 per cent and timber and joinery products decreased 0.4 per cent.
But construction innovation is also helping to derisk project and activate sites.
Salvo managing partner James Maitland says “part of it is working harder, part of it is working smarter, and probably taking a bit of risk on”.
Salvo is building a $220-million, 57-storey residential tower at Southbank in Melbourne, and is using Tier-1 building technology to create a two-stage sequencing of the building, which would enable occupancy of the lower levels while the second stage is built out.
“We’re using Tier-1 technology, with a Tier-2 mentality, which is just roll your sleeves up and get it done,” Maitland said.
“So leveraging the technology around some of those pain points, we’re seeing efficiencies there.”
While Maitland is focused on residential in the near term, he says office would be a strong investment into the future in Melbourne.
But it would require a long hold and the potential for significant capital expenditure to bring B and C-grade assets to standard.
Something Riverlee development director David Lee agrees with.
“A and B-grade office that was trading between 5 and 6 per cent, you’re getting 8 per cent now. At those rates, there is an opportunity,” he said.
“But B and C-grade stock is challenging to bring up to the market standard of today. Some buildings just can’t be retrofitted. If the returns were fixed, and you didn’t have the capex bill, the IRR would be amazing. But that’s not the case.”
Riverlee uses its own balance sheet to drive its development business, as well as the group’s private investment activities. Equity opportunities have been limited in the past few years, according to Lee.
“We have chosen to invest in private credit over private equity, because we are already on the equity side, and when you look at the opportunity and risk of equity versus debt, the risk stack (on equity) has outweighed the benefit,” he said.
“Cap rates have been smashed, interest rates are up, construction cost is up, program is out, and revenue hasn’t grown, the risks have just outweighed the opportunity.”
But MaxCap head of direct investment Simon Hulett said return prospects were improving.
“For people sitting on the equity side of the equation, we are currently seeing some improvement in forecast performance off the back of movement in the forward yield curve, which is helping to get the market moving,” Hulett said.
“There’s always been good opportunities to invest in direct real estate. I think the maturation of investment products in the credit space is the thing that’s really changed.
“For investors now, the quality and sophistication of products that they’re able to invest in across both real estate credit and equity provides much greater choice and a broader spectrum of risk-adjusted returns to create a balanced portfolio of real estate investments.”
