What Australia’s population boom means for property?

All signs point to migration driving Australia’s next property upturn. So what should developers consider before they lodge their next DA?

Elias Younes, Construction and Development Finance Manager, shares his insights from the construction frontline. 

More than 1.5 million migrants are expected over the next five years, and they’ll need somewhere to live. It’s one reason why housing price growth – especially in Sydney and Melbourne – has been sustained through 12 successive interest rate hikes.

Core Logic data suggests the last time housing values trended higher through a rising interest rate environment was the mid-to-late 2000s – a period when surging net overseas migration also boosted housing demand.

But before developers race to invest their capital in a high-end collection of luxury residences, it’s important to note international students make up almost half this year’s projected intake.

So the focus right now is on affordability.

“We are starting to see more affordable housing transactions, including student accommodation, boarding houses and build-to-rent in higher density areas, close to universities,” says Elias Younes, Manager – Construction and Development Finance with Assetline Capital.

Around 70% of migrants tend to settle in Sydney and Melbourne, but land values in Sydney are still relatively high. Melbourne’s inner city, Brisbane’s inner city and the Gold Coast may hold more potential for capital gain.

Here are three questions developers should consider before they explore funding scenarios.

Vertical housing or horizontal housing?

While analysts suggest there’s a ‘missing middle’ in medium density townhome developments, it’s increasingly difficult to build these cost-effectively ­– unless it’s at significant scale.

“The cost-to-build is effectively the same as a smaller house,” notes Younes. “That’s why we’re more likely to see vertical housing than horizonal housing developments.”

The NSW population is expected to hit 9.1 million by 2033, with 6.1 million of those living in Sydney. However, Charter Keck Cramer data suggests just 203,000 apartments have been completed in metro Sydney since 2009, and with medium- to high-density dwelling approvals still below average this chronic undersupply will continue – further fueling growth in unit rents, which are outpacing house rents.

“Governments understand they need to create higher density housing in areas close to transport and other amenity,” says Younes, believing mixed-use apartments with retail or commercial space built in will become increasingly popular. 

Build-to-sell or build-to-rent?

While it’s a relatively new concept in Australia, build to rent (or multi-family housing) is a mature model overseas – for example, institutions own around 40% of the US rental market.

“I think build-to-rent is a good model, but it’s still challenging to make it work financially in Australia because you can’t borrow at a fixed rate for 30 years,” says Younes. “That makes it difficult to create a sustainable profit model, even with the new state government incentives like the land tax discounts in NSW.”

Assetline Capital recently funded a $20 million loan for co-living student accommodation on Sydney’s Northern Beaches. “It’s a build-to-rent model, with the developer partnering with investors and a specialist management company,” explains Younes. “It provides income for the investors, and makes that lifestyle location more affordable for students. I’d expect to see more of these in the next few years.”

The construction loan is secured for 20 months with a 50% LVR, and the investors plan to refinance to a long-term loan once they have rental income to support serviceability. Younes says the exit strategy needs to be sound if you’re planning to retain the asset
post-completion.

“It’s part of our specialist lending solution set, and we will certainly consider these types of deals for an experienced management team with a realistic refinance strategy,” he says.

Co-living student accommodation on Sydney's Northern Beaches, CGI courtesy of MicroNest.

The traditional build-to-sell model is still far more common.

“Boutique, low density apartments in inner-city areas will always be in demand,” he adds.

And while overseas migration would usually directly impact rental demand, there simply isn’t enough stock available to rent with vacancy rates holding around 1% in most cities.

Some buyers might end up fast tracking a home purchase decision simply because they can’t find rental accommodation – and for first home buyers and newly arrived migrants, a new apartment build might be their best and most affordable option.

Optimistic forecasts or conservative contingencies?

There’s one other factor to weigh up before you help to meet the housing supply gap. Is it profitable?

“Labour and supply cost increases may have plateaued, but it’s still expensive to build and sometimes the numbers just won’t make sense for the developer,” says Younes. “You need to protect your equity and profit margin, and that’s tough when land values are still high in sought-after areas.

”First, make sure your feasibilities are realistic.

“We see a lot of developers who are overly optimistic – their expectations for build costs are well below the current market rates, while their net realisable value (NRV) forecast is at the high end,” he explains.

“Be conservative. If you think your NRV will be $2 million, run your numbers on $1.8 million. You’ll still walk out with some profit, plus you’ll be protected if things change during the build. And things always change.

”That’s why it’s also a good idea to add an extra layer of contingency.

“We used to allocate 5% for construction cost contingencies, but lately 10% is more realistic,” observes Younes.

“Think of it as 5% for changing scope, and 5% for unforeseen circumstances. In the last few years, the unforeseen has become BAU.”

And finally, make sure you’re allowing for a few more interest rate rises – because last year’s interest rates are unlikely to return.

Younes says an experienced lender like Assetline Capital will work with the borrower to make sure the numbers add up, and get another perspective. “During our due diligence, we’ll work with a quantity surveyor and valuer to run our own feasibilities. It’s not just to protect our own interests – it’s to protect the developer.”

Assetline Capital’s active approach to construction lending also helps sustain the developer’s cash flow during the build.

“We’re increasingly seeing suppliers and subcontractors ask for large deposits upfront, which could mean hundreds of thousands of dollars out of pocket for the borrower while they wait for a lender to reimburse them. We can make those payments directly, once we’ve made sure the milestones are being met and the supplier is legitimate.”

Ready to build?

In a supply-constrained market, there are opportunities for developers who have the capital ready to start projects now. However, it’s important to understand your target buyer (or renter) and what they can afford – and make sure you check the numbers stack up. Developers can play an important role in helping Australia overcome the current housing supply crisis – but they also need to be able to make a profit.

If you have a construction deal you’d like to discuss, please get in touch.