2023 was a challenging/difficult/disastrous year for the property industry … feel free to choose your own adjective, but for almost all in the industry this covers the spectrum. 2024 is predicted by most to be more of the same with cautious green shoots of optimism about 2025.
Accepting that none of us can predict the impact of global factors such as the Middle East conflict, the US election or the next pandemic, for the sake of our eco-system and our sanity we need to strategise and plan our next 12-24 months. So, with various degrees of confidence let me share my predictions on the 10 areas I am asked about the most:
The consensus view, which I agree with is that we are near or at the top of interest rate rises. What is opaque is whether there will be any material lessening of the cost of debt finance from any source in 2024, and here my personal view is “no”. Developer finance does not have the same volatility as home loan finance. The demand for debt refinancing is deep so that even if the demand for new project financing is down there will be a lag before investors are prepared to accept lesser returns. First mortgage funding from the non-bank sector in 2024 will still in my view fall in the 9-11% range, plus valuation and establishment, house costs. Traditional bank funding rates may soften slightly and where there is competition to lend such as residual stock or data centres there will be wiggle room to negotiate.
Construction costs have stabilised, but they remain significantly higher than the historical costs developers were obtaining to achieve a 20% plus Internal Rate of Return (IRR) in feasibility. There is no expectation that they will materially reduce and in fact, those builders that have survived are determined to accept less risk and demand more realistic margins. Builders in 2024 will continue to compete with government projects for sub-contractors and labour, which will likely maintain the existing level of costs
New protections for defect and warranty processes for apartment buyers, which are long overdue, will further add to developer/builder costs, as will government taxes and levies on all stages of the development process.
Inflation in 2024 will be less of a concern than in 2023 but the cost of housing and rental with the housing supply shortage, plus the cost of labour, will mean it will continue to be a factor influencing Reserve Bank and Government policies. That in turn may delay or preclude stimulus and reform packages which our industry and the economy are desperate to explore and implement.
Unemployment rates will increase in 2024 across most sectors. The lack of investment by the private sector in the last few years and record insolvencies, especially in our industry, must impact. Rising unemployment and costs of living pressures are impacting housing demand. Low unemployment is usually regarded as a positive sign for the economy but the very low rate we have experienced has contributed to inflation and reduced productivity.
The most profound change I witnessed in 2023 was the drying up of equity capital. There were several reasons, but the main ones were the high rates of return available on secured debt and the diminution of confidence, which in turn reduced the appetite for risk. Equity capital is the oxygen of our industry, and its absence leads to deferral or cancellation of projects.
Innovation, entrepreneurship and scaling require equity. Private funding must be supplemented by government, institutional and superannuation funds support. I have not yet seen signs that 2024 will see an improvement in equity availability, but this can change quickly if some of the concerns I have mentioned here are addressed.
The clearest trends of 2023 were the investment markets’ lack of love for the office sector and the strengthening of the student accommodation, land lease community and data centre sectors. Logistics remained strong in our geography but softened internationally (always a signpost). Build to Rent, a champion of 2022, began considering value management options in 2023 as supply, particularly in Victoria, increased. All these sectors share the commonality of a guaranteed long-term cash flow, the ability to attract funding or funds through sales, and most importantly the ability to attract investor capital and create a funds management platform.
I expect 2024 to mirror 2023 with the hope that funding and delivery models will evolve to allow the exploitation of the insatiable demand for residential accommodation. Support of the government by the reintroduction of off-the-plan stamp duty concessions and planning reforms would also greatly enhance the prospects of this sector. The Build to Sell accommodation sector is Victoria’s best chance of economic recovery. Other 2024 growth prospects are in the affordable housing and social disability accommodation sectors. Wellness and Health offerings which tend to combine with mixed-use developments (rather than stand-alone developments), will continue to be supported.
Credit Debt Providers
2024 will continue the evolution of the non-banking sector. In recent years we've seen Qualitas go public and Maxcap Group partner with Apollo Global, a large US fund. Most of these alternate credit debt providers are continuing to evolve their business models including enhancing their capital sourcing.
Several of these credit debt providers, which in the main started as Mezzanine lenders, are now capable of full lending packages exceeding $100m. The larger houses saw their average loan size increase significantly in 2023 as they continue to provide credit where the Banks ordinarily would have even as recently as 2-3 years ago. 2023 saw a strong year of double-digit returns for investors, but cracks developed with borrowers suffering from construction and finance cost issues. Many of the houses are sitting on problem loans but having transitioned in the main to fund models (as opposed to special purpose or syndicate models) the potential loss provisions are relatively modest.
The hunger for capital, both debt and equity, will see developers and builders collaborate deeper with these credit houses to facilitate developments and create new platforms where fees will be generated and shared. I see this trend as progressive and promising.
The biggest question for 2024 will be can I fund my project or my business at a sustainable cost and with sufficient certainty to progress or even scale? The developers and delivery partners that resolve that question positively will flourish, but it will require innovative and credible planning. The days of large-scale pipeline development financed by banks and high-net-worth backed funding providers are rapidly diminishing. Developers not only need to forge delivery models with builders and consultants, but they need to resolve whether they want to create internal funds or partner with fund originators and administrators. The answer will largely lie in the culture of the developer and whether it wants the responsibility of investing and managing third-party funds. Whichever model is preferred, sharing in the fund management fee should be a paramount consideration.
Confidence creates innovation and allows for a risk appetite. I heard it described recently as “higher conviction strategies” which I liked because it suggests it is based on instinct and analysis. 2023 saw a trough of confidence. My conversations to date suggest it will be late 2024 before any incline occurs.
Despite Australia having almost all the requisite fundamentals such as security, a functional and exemplary legal system, an educated workforce, resource richness, and a gateway to Asia, it lacks the confidence to optimally exploit those fundamentals. The perfect example of this is that despite having an insatiable demand for residential dwellings, at various price points, which a very willing and competent industry would happily service if some minimal taxation and planning reforms could be implemented, we cannot get Build to Sell projects at scale started. This lack of vision and leadership cruels confidence, but I believe the industry has enough gumption and flair to generate confidence by 2025.
A project or development must generate above a 15% plus annual IRR, and have the capacity for contingencies, to justify the time, risk and effort involved. The material elements of feasibility are the potential net revenue minus the land or site cost, the construction or development cost and the finance costs. 2024 will see little movement in these elements although over the next few years, I believe Victorian residential apartment prices will increase between 20-50% over the next few years (they will still be far lower than equivalent Sydney prices).
Personally, I cannot envisage material improvement in feasibilities in 2024. There is a great deal of work on delivery, funding and business models being undertaken in 2024 to create better feasibility models into 2025 but I do not envisage a collapse in land prices, and I believe planning and taxation/levy reforms will also be required.
My prediction is 2024 will be as challenging/difficult/disastrous as 2023, but if it is used wisely to lay the groundwork for 2025 and beyond it may well be considered the year where opportunity was recognised, and the foundation was laid for sustained success.
Author: Benni Aroni, Client Director – Property at Pitcher Partners
Disclaimer: This article contains general information and should at no time be considered financial advice to the reader. The reader should always verify their situation with their financial advisors before taking any further steps.