Since the Irish property bubble burst, the price of development land has fluctuated from the heady prices of boom time to an all time low. Now as prices are beginning to recover, the effect of the recession on the costs of development are emerging. While the cost of purchasing the initial “raw material” of land is showing good value, there have been changes to the industry which have caused the cost of development to become almost cost prohibitive. A cost benefit analysis of a development shows that profit margins are becoming increasingly tight and therefore development is uneconomical. Given the current housing crisis, developers are under pressure to start producing units to meet the demand but little is being said about the feasibility of producing the product in the volumes required.
There are several factors at play that account for the potentially uneconomic costs of developing land presently. Some relate to legislative changes and introductions over the past seven years and others are commercial reactions to the recession and the credit bubble created in the boom.
The main challenges faced by developers are access to finance, the new building regulations, minimum size confusion, scarcity of specialized contractors, pricing projects competitively and the planning regime. The main commercial hurdle developers are encountering is access to competitively priced development finance.
While acquisition costs of land are reasonable (stamp duty is still at 2%, down from heights of 9%), the costs of planning and zoning due diligence remain high. Sites being sold with an existing planning permission are obtaining premium prices. However, if you are in the market for a greenfield or brownfield site, it is extremely important to carry out a feasibility study as to whether planning is likely to be granted and in what realistic timeframe. This will involve hiring planning and possible zoning consultants to ascertain whether your proposed development fits into the local authority’s development plan for the area, whether the relevant services are in place and have the capacity to carry the additional demand which your development will create or whether you will need to budget the costs of procuring such services into the overall cost of development. Increasingly developers are engaging specialist construction costs monitors (the modern day QS) prior to even looking at development sites, to ensure they can cover these costs and planning delay issues before turning the sod.
In certain areas development bonds are now significantly higher than they were prior to the recession as local authorities are attempting to ensure unfinished estates and the associated costs of completion are covered in full. Extreme examples are causing headaches for developers, for example it can cost a builder upwards of €80,000 just to begin work on a house site on Glenamuck Road, in Dublin 18. The Department of Environment have recommended that local authorities include a condition in planning permissions which allows for the recalculation of the bond value by reference to the House Building Cost Index or CPI if the development is not commenced within a certain time following the grant of permission. Usually local authorities will pursue a developer to complete a development via the enforcement order mechanism under the planning legislation before drawing down the bond. Before considering buying a site it is vital for developers to assess and properly budget these costs as they can vary wildly within a small geographic area or across county borders.
If you intend acquiring development land that is not suitable zoned for your development, further due diligence will be needed to ascertain the likelihood of the lands being re-zoned and the intentions of the local authority in its development plan. Most county developments plans are up for renewal in the next 12-24 months and this presents the opportunity for land holders to address concerns to Councilors and make land more appropriate for the right kind of development. Re-zoning of land can take time which is another factor to consider. In addition, the new Regulation of Lobbying Act, 2015 needs to be carefully considered if you intend approaching a local authority regarding a re-zoning request. The windfall tax levy was introduced in the recession as a measure to counteract the effects of what was a highly politicized re-zoning process which existed in boom time. It applies to all land where the re-zoning took place on or after 30 October 2009 up to 31 December 2014 at a rate of 80% of gains attributable to re-zoning. In addition material contraventions to development plans were added to the scope of this levy following the Finance Act 2010 to decisions made on or after 4 February 2010. The levy which failed to collect any significant revenues was abolished in 2014
Part V Compliance
Residential developers will be aware that Part V social and affordable housing obligations have changed since 1 September 2015. Amendments were introduced under the Urban Housing and Regeneration Act 2015. Exemptions have increased to developments of 9 or less houses or for housing for land on less than 0.1 hectares or less or for the conversion of or reconstruction an existing building to create one or more dwellings provided half of the original fabric of the building is retained. Local authorities are now entitled to acquire up to 10% of land for social and affordable housing in a housing development. The local authority’s options as to how Part V will apply have also changed. The default option of transferring land subject to planning permission to the local authority remains but the land option must be acceptable to the local authority. Other options include transferring completed units on the development to the local authority, transferring completed units on other land/housing stock held by the developer, grant long term leases of properties or through a combination of all four options. The removal of transferring partially serviced sites, the option of transferring land not subject to planning permission within the local authority’s functional area and the option of providing a cash payment in lieu of social housing have all been removed. Arguably the default option of transferring land to the local authority is the most economical option now available to developers under the new Part V regime.
While the amended exemptions are to be welcomed, they are limited. It is advisable to discuss Part V compliance with the local authority in advance of submitting a planning application and developers must budget for both the cost of pre-planning meetings and compliance with their Part V obligations. This will add additional time to the planning process and naturally Part V compliance will come at a financial cost as there will be less units in the development to bear the build cost. The costs of Part V compliance is a factor which will need to be incorporated into the sales prices for finished units.
The requirements to deliver dual aspect apartments and a small number of units per core result in higher build costs. It is arguable that higher density apartment units can be built if these requirements were amended without compromising building standards. Attempts to allieviate the cost problems in the old minimum design standards has introduced more uncertainty. While the revised minimum standards reduced the overall apartment sizes, increased units per core and removed the dual aspect requirements in certain circumstances, the new standards did not allow for any decrease in minimum room sizes. Much has been made of this oversight in the media and until such time as clarity is brought to the matter, this initiative will not serve to reduce development costs.
The new building regulations have been in force now for almost a year and a half. The general consensus towards them is that some requirements are excessive and are leading to additional design and build costs. The introduction of assigned certifiers and bank monitors have led to more scrutiny of the construction process, which must be welcomed but such regulation must also be sensible and practical
Access to finance
Access to finance at competitive rates is the most difficult challenge for developers at the moment. The most popular alternatives to traditional banked development finance are loans from private equity houses, through joint ventures and through mezzanine finance. The cost of arranging funds from private equity houses and mezzanine finance is much higher than a commercial loan from the banks. Fee arrangements for providing the facility, high interest rates, exit fees and early payment penalties are all common features of private equity. The arrival of funding from the Strategic Investment Fund should help with easing some of the market pricing but the pillar banks are still not actively supporting development in a sensible way.
Recent economic improvements, albeit slight, have seen financial institutions re-entering the financing of developments and commercial property. In this post-recession market, borrowers are experiencing exacting financial due diligence and security requirements from lenders. Potential borrowers should expect the bank to require a full title investigation, floating charges, fixed charges on the development property, collateral warranties from all contractors and sub-contractors along with the usual corporate documentation. In addition lenders are seeking that their interests be noted on various insurance policies of both the borrower and contractors. It is advisable that during the facility negotiation process that borrowers request the lender’s exact insurance requirements to ascertain whether both the borrower’s and affected contractors insurers have the capabilities to comply with the lenders requirements.
While is it reassuring to see rigorous due diligence occurring, lenders should have as much of their documentation in order and also to expect a longer process in the completion of drawdown and should budget accordingly. The increased level of due diligence has led to the knock on increased costs. Overall the financial costs of developing property have increased due to the knock on affect of increased due diligence which has lengthened transactions, increased legal fee cost, bank monitors, cost of insurance, all cost insurance.
While the property market has recovered significantly in the last eighteen months, the Central Bank’s regulations on mortgage lending have taken the “heat” out of the rising house market. Introduced in February 2015, these rules aim to curtail bank lending to first time buyers by limiting the loan to value ratio of 3.5 times your gross salary to your maximum mortgage. First time buyers must now be able to have saved 10% deposit on purchase prices up to €220,000 and 20% on any excess over €220,000.The rules have been in place for just over a year now and a levelling off of house prices in Dublin has occurred while prices of homes outside Dublin is still recovering.
Dublin is still recovering
Balancing the expected costs of the entire development process and what are deemed affordable housing in society, it is clear to see that the property market is flat with little opportunity for making a sustainable profit/income stream. New housing initiatives and strategies have been announced by the Housing Minister. They include the provision of an infrastructure fund to local authorities to assist in servicing sites and a fast track planning process for large scale mixed use developments. In addition the vacant site levy is due to come into effect next year. Given the current housing shortage, incentives introduced thus far seem to have taken a more “carrot” than “stick” policy approach but it remains to be seen if they will be sufficient to reduce the overall costs of development and increase profit margins.
This article was first published in Irish Construction Industry Magazine – July/August 2016.
For more information contact Sharon Pennick.
This publication is for guidance purposes only. It does not constitute legal or professional advice. No liability is accepted by Ogier Leman for any action taken or not taken in reliance on the information set out in this publication. Professional or legal advice should be obtained before taking or refraining from any action as a result of the contents of this publication. Any and all information is subject to change.