Australian property developers should prepare for a downturn not seen in 30 years

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  • A new report from Ernst and Young (EY) says Australia’s property industry is facing a downturn not seen in 30 years.
  • It says there’s unlikely to be a housing crash, but falling property prices and tighter lending standards has increased uncertainty over the outlook for new projects, developer cash flows and debt repayments.
  • The report says it’s critical the property sector adopts a proactive approach to reducing risk.

Australia’s property industry faces a downturn not seen in 30 years, and that means property developers should be taking measures now to protect themselves, warns a new report from Ernst and Young (EY) Australia.

“Australia’s economic fundamentals are strong after 28 years of uninterrupted growth. The nation’s GDP growth currently sits at 3.4%, inflation at 2.1% and unemployment below 5.5%. Investment in infrastructure and dwellings remains high, supported by a large pipeline of work,” EY says.

“However, there are clear signs the residential market is slowing.

“CoreLogic’s mid-September update finds house prices have fallen by 5.9% in Sydney and by 2.5% in Melbourne. Together, these two cities make up more than half of Australia’s entire residential real estate market.”

With home price falls in those cities now beginning to be mirrored in smaller housing markets, EY says the outlook for developers is uncertain, particularly at a time when lending standards have been strengthened compared to periods in the past.

“Unlike previous downturns, interest rates look set to remain low. While we don’t envisage a crash, it has become much harder for homebuyers and developers to secure finance,” said Richard Bowman, Real Estate Partner at EY Australia.

The report warns the combination of falling prices and tightening lending standards has had negative implications for not only developers but also builders and lenders, noting slowing project and land sales may affect the timing of cash flows and payments, leaving developers vulnerable in the medium-to-long term.

It says declining land values may impact loan-to-value ratios and require developers to generate more or new equity to get new projects off the ground while declining sales and revenues from projects may not cover returns to equity and debt holders.

“Such a scenario may deter existing and future investors from continuing to invest in these types of projects. Capital starvation will lead to distress and likely destruction of value on those projects,” the report says.

And combined with lower profit margins, EY warns this could see planned developments scrapped.

“Shrinking profit margins may prevent developers from recycling capital and profits into future existing projects which may put those projects in jeopardy” it says.

“This could lead to an increase in ‘fire sales’ which will re-set the market and cause further concern from a finance perspective.”

Given the potential risks, Bowman said it’s critical the property sector adopts a proactive approach to reducing risk, but also taking advantage of opportunities.

“At this stage in the property cycle, developers need to make sure their projects are the right size for the current market,” he says.

“It’s a good to time to re-run their feasibilities, to ensure they suit current conditions.

“Developers may need to diversify capital sources and consider options like build-to-rent. It’s also a good time to manage your cash flows and check on the solvency of your contractors.”

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