The Four Horsemen of NZ Property Development: Banks, Council, Builders & the incompetence of the Real Estate industry
Over the course of my career, I’ve often been asked to discuss financing structures for development projects both large and small and to provide advice to developers on how to assemble the appropriate capital stack for large format residential projects.
The cost of new housing in New Zealand is high and there is an unholy trinity of woe as it relates to financing, planning and construction that has meant that the cost of new housing will remain unnecessarily high for the foreseeable future unless there is a company that is prepared to challenge the status quo and disrupt the entire industry.
Development financing is a complex topic in New Zealand, not least because there are many vested interests.
Most people outside of the industry won’t realise that the larger residential build-to-rent (BTR) and buy-to-let (BtR) developers are unable to be funded locally. That’s because the size and scale of projects are beyond the capacity and or appetite of the local banking market.
Let me explain, all lenders have their “sweet spot”.
For the smaller regional banks all the way through to KiwiBank, the maximum they will lend to a single developer is $30m. To be clear, this isn’t for a single project - it’s the maximum they will lend across multiple projects to a single client. For developers undertaking slightly larger projects, the excellent Property Finance Unit at the ASB and Westpac have a sweet spot around $20-$30m for a single project. They are unlikely to have multiple projects of this size with a single client.
Next come the Chinese Banks ICBC and CCB who have a long term commitment to the New Zealand market, a talented & progressive management team and will support a larger deal size of around $50m. They will be a force to be reckoned with in future years, however, their preference like the ASB and Westpac is to limit their exposure to one project at a time.
Both the BNZ and ANZ have been the preferred lender for large scale residential developers. However, in recent years they have applied a hand brake on development lending as they grapple with the Reserve Bank's requirement to increase their capital by $20 billion each, which was initially proposed to be funded from equity. While these requirements have softened since COVID-19, the banks are fully aware that they will have to tap their shareholders for equity at a future point which has slowed down lending to development clients. With both the BNZ and ANZ focussed on their existing clients, they are unlikely to have many transactions for residential development that are north of $75m.
Of course, the banks are able to “club” together for mega-deals, however, the syndicated banking market has been quiet over the past few years which has provided an opportunity for major global institutions to “bank” a small group of large-format developers.
In summary, New Zealand is woefully underbanked and this provides a significant hurdle for large scale residential development which is an industry that is reliant on the availability of capital and certainty of terms and pricing.
While development lending has been choked for years, the major banks are significantly growing their profitable retail books.
Of course, restricting supply and maintaining house prices massively protects their retail mortgage book and is the subject of an entire book for someone motivated to write one.
The banks rarely lose (and if they do they are likely to get bailed out by the taxpayer) and post COVID-19 their quarterly profit announcements will show that while parts of the economy suffer, banking will continue to asymmetrically prosper within New Zealand’s closed and regulated market.
So what does this mean for development at scale?
Well to put this in perspective, CBRE have again confirmed in their June 2020 update that Du Val is New Zealand’s largest apartment developer. In 2018 through our construction partnerships, we were also the country’s 8th largest home builder. As a large scale residential developer and builder, we have a current debt requirement of approximately $425m annually which will continue to grow to meet the demand for housing.
To date our lending has been spread far and wide, however, the reality is that there isn’t a bank in New Zealand that is able to support our business over the medium term.
While the lack of capital is concerning for our housing market, the problem goes far further than that. Many of the local banks misunderstand risk and haven’t adopted best practice international standards as it relates to development lending.
The largest residential developers in the world are not funded on a Mickey Mouse basis, project by project. They are banked centrally and their senior management in conjunction with their bankers provide a treasury function across multiple locations and multiple projects to deploy capital as it is required.
International large scale development businesses invariably self-deliver their own projects. Design coordination and management along with tight cost control have proven to be the gold standard in England, Canada, USA and Australia for many years. However, in New Zealand many banks require developers to outsource their building contracts to third party builders where there is little transparency as to the financial substance of the contractor.
Over the course of my 25-year career I have had three builders go bust on projects and it is a daily headache worrying about the solvency and competence of third party contractors.
Building margins tend to be below 5% which is substantially below the margin a developer is required to achieve to obtain bank financing. While New Zealand contracting businesses generate monthly cash, they don’t have the balance sheet and financial depth to withstand significant setbacks on a large project and it’s this lack of resilience which has meant that New Zealand is the burial ground for many head contractors.
Compounding these issues, the quality of design coordination and management of many New Zealand contractors is woeful. This leads to cost blowouts and significant delays on-site, which ultimately leads to a wealth transfer from the developer to the lender who continues to receive interest as project completion dates slip.
New Zealand is still very much the Wild West of construction and also of development lending and this needs to change if we are going to deliver housing at scale and at pace.
Self-delivery is the international gold standard for a reason. There is absolute transparency through the building process and an alignment of risk and reward. Management teams become highly specialised at delivering up to 10 large format residential projects a year as opposed to the head contracting model, delivering 100’s of projects of different types split across multiple sectors and multiple clients.
Subcontractors far prefer to work directly for the client. Risk is transparent and they have a great deal of certainty about payment and continuity of work. They also become specialised and management teams become aligned to deliver the best possible outcome for home buyers. Tragically when a head contractor goes pop, it’s the subcontracting businesses who suffer and this builds little confidence in the industry.
Banking and then building large residential projects at scale is a challenge that would test the patience of a saint!
The gap in the market left by the banks who are focused on their retail book leaves room in the market for domestic finance companies who are generally backed by well known ultra-high-net-worth families who value their privacy. The ticket size for a single deal ranges from $2m-$20m and this has been a profitable part of the market where interest and fees as high as 25% per annum are able to be charged.
New Zealand’s woefully underbanked market has been a license for finance companies to print money. Over the past decade, many fortunes have been made funding small and mid-sized projects and the cost of capital invariably is passed on to the home buyer which contributes to the high cost of new housing.
So where does this leave the New Zealand housing market? Already hit with a highly regulated and time-consuming consenting process, and a regional tax of approximately $40,000 per new house created paid to the local authority as development contributions and other fees, a project has to be able to withstand the burden of expensive and problematic financing.
To compound things further, we are a nation that imports the majority of its building product. A weaker dollar means that building supplies become more expensive.
When you take all these factors into account there is little hope that we will be able to make housing cheaper and there are few individuals who are prepared to enter the development industry when they truly appreciate the difficulties ahead of them.
There are many people who think that the solution to the high cost of new housing is reform of the RMA, offsite manufacture or volumetric construction methodology. However, the reality is that the financing, consenting and construction sectors need to be disrupted in order for meaningful progress to be made.
This unholy trinity of dysfunction is able to be disrupted by those prepared to challenge the status quo and for those that do there is substantial opportunity.
The final horseman is of course the real estate industry who have little skill in marketing new housing with a few notable exceptions. Estate Agency is the home of the talentless and developers who haven’t internalised their sales platform will hand marketing dollars to agencies who will use this money to establish their own brands with no accountability for results.
The five large global agencies “specialising” in project marketing are little more than order takers providing no service to a developers client and this is equally true for domestic agencies.
We sell hundreds of properties each year and the real estate community sells less than 10% of these. This is a frightening statistic for first-time developers who will rely on a slick sales pitch and make plans for the future based on promises that will never be kept.
After a quarter of a century building housing in New Zealand and accommodating tens of thousands of people, it’s time for us to stop complaining and lead the industry on the path to changing the BtL and BTR sectors.
Disruption across other industries has become a study in innovation as has been seen with Uber, Netflix, Google, Tesla, Facebook and Amazon and it’s time this spirit of innovation was brought to the new homes sector.
Since COVID-19 we have already seen the government bypass the RMA for “shovel ready” projects and it’s our hope that this heralds a new wave of construction across the country. While it is unlikely that we will entirely remove the red tape that’s been choking New Zealand for decades, I am hopeful that this is the start of things to come to meaningfully deliver housing at scale.
They say that “if you want something done right then you need to do it yourself” and this is our guiding principle to disrupt the sector.
Our sales platform has already been internalised and while many businesses are contracting during this time, we are on our way to recruiting another 30 people in New Zealand who are the best of the best from the project marketing industry and provide the training they desperately lack within the real estate industry. Globally we are recruiting 250 people for our offices in London, Hong Kong and Singapore. Technology has changed the way that many businesses operate and the opportunity to release projects on a Property Technology (PropTech) platform will ultimately end the chokehold that global agency has had on the industry. CGI development and 3D virtual experiences of new homes allow buyers to familiarise themselves with every aspect of a project and proximity is no barrier now for clients located around the world.
Research is able to be democratised for BtL buyers providing access to information in a way that has only been previously available to institutional buyers. With social distancing a part of our lives for some time to come, contracts able to be exchanged using the blockchain which will over time become the new normal, streamlining what has traditionally been an archaic process.
Our construction team is highly specialised with top talent and methodology brought in from London and Germany. While we fundamentally support the New Zealand industry, we will continue to foster a culture of client-focused excellence and provide the international training and experience needed to specialise in iconic residential-led projects. Design, interior design, design coordination across multiple engineering disciplines and procurement have all been internalised with the sole focus on delivering the best experience for new home buyers.
Software is revolutionising the international construction sector although this has not been widely adopted in New Zealand. Building Information Management (BIM) systems track every part of the design and build through to the “as-built” document set as a residential community is handed over to the facility and building managers on behalf of owners. This fosters a culture of continuous improvement and transparency of information. The Japanese call this management style “Kaizen” (meaning change for better) which is perfectly adaptable for the manufacture of homes.
In a global world for those with scale, there is no reason to remain trapped in New Zealand with our limited debt and equity markets.
We are locating our head office in the Far East as a halfway point to better access European, American and Asian financial markets. Hong Kong and Singapore are hubs for financing where US capital along with money from around the world gathers, looking for a home. New Zealand is a safe haven economy and should be represented on the international stage to rebuild our economy post-COVID-19.
To provide surety of financing our Funds Management division Du Val Capital Partners has launched our 15th Fund. We are raising NZD$100m, providing investors with the same security our banks have previously held. We are able to pay our investors returns that make sense for both parties, without incurring the cost of middlemen or large fees to third parties reducing the cost of financing.
Centralising our funding backed by the full weight of our balance sheet enables us to provide a treasury function across our group deploying capital into projects that have been well-founded and well sold which will enable us to reduce the cost of new housing for New Zealanders.
This gives us the flexibility to extend our capacity through partnering with global banks such as ICBC to provide a line that will enable us to deliver over 1,000 new homes a year into the New Zealand market and take our rolling debt to NZD$425m.
As we continue to transition to deliver housing at scale, we will be the first New Zealand residential developer ready to IPO at a market valuation in excess of $2b in either Hong Kong or Singapore providing warm new homes for New Zealanders long after I’m dead and gone.