The high rise environment in Australia changed in most capital cities, but particularly in the eastern cities of Sydney, Melbourne and Brisbane during the last residential property market cycle, which ran from 2012 to 2018. Prior to 2012, smaller numbers of residential dwellings were built, and the scale and complexity of residential buildings was lower.
Previously, the industry considered buildings over 100 units to be large and projects with yields above this were staged. In the current cycle 100 units was considered a medium sized project and projects with 200+ units in a single building became more common, with multiple stages of similar scale often being built concurrently.
High rise residential construction has become the norm for many cities in the world, but for Australia this is somewhat new and previously this domain was reserved for the more experienced developers and builders, generally Tier 1 and Tier 2. With anything new there are normally teething issues. High rise residential construction is no different and, in our view, the very public defect issues experienced in the following examples are the tip of the iceberg:
- Combustible cladding materials in Melbourne and across Australia
- Structural defects in Sydney projects (e.g. Opal Tower, Mascot Towers)
- OHS issues at Lachlan’s Line at Macquarie Park
Considering the volume of high rise residential construction over the current cycle, we expect many more problems to surface over the next 2-6 years, as new buildings reach the end of their structural warranty periods. This should concern owners, builders, developers, financiers and governments.
Buying off the plan should entail a lot of due diligence, commensurate with the risk. Large projects become even more complicated with the proliferation of mixed-use retail which brings strata complexities, different owner motivations and fit-out works that occur after the occupation certificates are issued. Quality of construction is very important and this will have longer term financial implications with ongoing maintenance costs, strata fees and resale values.
In a bull market, time is of the essence and buyers exhibit a fear of missing out. There is less opportunity to make extensive enquiries, particularly about the quality and experience of the developer and the builder. Furthermore, in some instances the developer commences marketing prior to entering into a contract with a builder.
Conversely, in a bear market, like we are currently experiencing, there’s less pressure to act and buyers have less justification for being uninformed as they should have as much time as they need to conduct their due diligence on the project, the developer and the builder. To the extent that they can’t get comfortable with this, they can always move onto another project.
Buyer beware… Do home buyers and investors understand the interaction between quality and the risk?
In NSW, the Home Building Act 1989 (the Act) makes it mandatory for builders of residential buildings up to 3 storeys to obtain Home Building Compensation cover (HBCC) to provide a safety net for home owners in the event of defects and an insolvent builder. The Act excludes projects above 3 storeys (i.e. medium and high rise), adopting a buyer beware stance that assumes owners in these cases are sophisticated and not in need of the same level of consumer protection. As the average height and size of projects has increased in this cycle, more purchasers fall into this category of not having the protection of HBCC and therefore rely on the warranties provided by the builder and developer to rectify defects.
Historically few purchasers have understood the implications of this risk and we suspect even fewer have taken the time to investigate the financial standing of the builder and developer in circumstances where there is a risk of defects on a completed project.
We asked an experienced project marketer to provide their view of the level of understanding presales purchasers have on this topic. They explained that purchasers of off the plan and completed stock are very concerned about this risk and its reflected in the questions they’re asking. They advised that media exposure has been delaying and, in some instances, deterring purchasers from making a commitment, even were the project is completed as they question how the building will present in years to come. They want to know:
- Who is the builder, what projects have they completed, what awards they have won?
- What is their defect track record, have they been in any defect disputes, all of which is public information and readily available?
- How much stock is the developer holding and can they control the strata if there are defect issues?
- The structural elements of the building and the load it can take after fully occupied
In contrast to the past, buyers are getting very savvy with their due diligence, they follow reputable builders with a proven track record and its important in the marketing process to promote the builder, offer completed projects to look at and highlight quality control. This is as important than promoting the developer in the current market. Some buyers are even preferring buildings that are +3 years old as they have formed the view that any major structural issues are likely to have been identified by this time.
Realestate.com.au recently conducted an online survey (The Developer Insight Series) of 10,196 would be purchasers across four categories, being:
- First home buyers
- Upsizers
- Downsizers
- Investors
We highlight the following builder or defect related questions and buyers’ responses, and make our own observations:
| Question | Buyer Preferences | Our Expectation |
|---|---|---|
| Benefits to buying off the plan | Only Upsizers ranked a Builder guarantee as their number one preference, no other buyer category had it in their top 3 | We would have expected “First Home Buyers” and “Downsizer” to prioritise this benefit |
| Barriers to buying off the plan | Common concerns across all categories:
| None of the categories included any of the following items related to the builder in top 3:
|
| What do buyers look for when shortlisting projects? | Common preferences across all categories favoured:
| None of the categories included any of the following items related to the builder in top 3:
|
| Importance of the builder in decision | All categories responded as follows:
| Whilst 50% of respondents ranked the builder as Extremely Important, we’re surprised to not find a higher rate i.e. 70%+ |
What does this mean for residential development?
Given the extensive news coverage and social media influence, we expect an evolution in the due diligence process:
From the buyer’s point of view
- Initial wariness of off the plan purchasing due to fear of defective works and the perception of and/or value of the building
- A flight to quality, namely projects developed and built by established, experienced builders
- Buyers to undertake a greater assessment of the builder and the value of the warranty provided, for buildings over 3 stories
- More social media influence, including forums on buyer experiences with builders
- Insistence on extra protection in presales contracts in circumstances where a builder is replaced, giving greater rights of rescission
From the developer’s point of view
- Greater consideration in the selection of the builder and how it will impact presale marketing
- More explanation of who the builder is, their experience etc. and more likelihood of contracting with the builder prior to commencing marketing
- Difficulty in procuring project finance where the builder presents a higher risk
From the financier’s point of view
- Difficulty in financing projects were presales rates are low
- Preference to fund more experienced builders and developers, with stronger balance sheets
- Greater consideration to the selection of the builder and how it could impact presales settlements
- Presales purchasers’ rescission rights and definition of qualifying presales
- Greater financial due diligence on the builder, their experience etc.
Can more be done to improve transparency and protect purchasers, financiers and developers?
Ultimately buyers hold the power when selecting a residential property. If buyers make informed decisions, and do not commit to poor quality or defective projects, the builders and developers of those projects will be forced to improve to meet the market or will exit the market.
Unfortunately our free market model has not provided great protection for consumers. Generally speaking, many home buyers do not possess a high level of experience in construction and often make emotional decisions based on location, display apartments and cleverly prepared marketing packages to commit to one of the largest investments of their lives.
The NSW Government’s introduction of the 2.5% developer bond in high rise (above 3 storeys) strata construction is not as attractive a risk mitigant to a purchaser as HBCC, because it is an immaterial amount compared to the cost of rectifying major structural defects in a substantial, high rise building.
Some suggestions that need to be considered include the following:
- Restricting the size of a construction project based on the strength of a builder’s balance sheet, in all states (like the Queensland licensing model)
- Matching the developer 2.5% bond, with a 2.5% builder bond, taking the total to 5%
- Increasing the statutory warranty period for structural defects to 10+ years
- Require higher contributions into strata sinking funds
- Increasing education and buyer awareness of the builder risk and builder history
- Providing government funding for stakeholders to investigate and minimise phoenix activity
- Giving purchasers greater rights of rescission in circumstances where structural defects and poor workmanship become apparent before completion.
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