THE PROPERTY COUNCIL OF AUSTRALIA'S QUARTERLY SURVEY OF PROPERTY INDUSTRY CONFIDENCE RELEASED IN JANUARY DEMONSTRATED THAT WITHIN THE AUSTRALIAN PROPERTY INDUSTRY, THE TWO-SPEED ECONOMY IS WELL AND TRULY ALIVE.
The resource-rich states of Western Australia and Queensland saw significant uplifts in industry confidence from already strong levels; whilst the big states - New South Wales and Victoria - both showed falls in confidence. Victoria dipped into negative territory, as did the Australian Capital Territory. At the extremes were the Northern Territory, with booming confidence; and Tasmania, in the doldrums. This demonstrates the difference that significant projects can make, with the Northern Territory being the beneficiary of the AU$30 billion IMPEX Ichthys Gasfield project and the resources boom in Western Australia, South Australia and Queensland leading to over AU$140 billion of committed investments to iron ore, coal, gas and associated infrastructure projects. These states will have their economies underwritten for the foreseeable future by the almost insatiable demand for iron ore and energy coming from China and India as the largest economies in Asia.
Victoria, which has consistently shown strong growth over the last 10 years, has finally started to lose its gloss. A change of government has led to something of a policy vacuum and the rate of population increase, which was 80,000 to 100,000 people per year over the last seven years, has slowed. Economic growth has slowed with it.
One of the key negatives is the continuing credit squeeze, which is anticipated to worsen rather than improve in coming months. Since the Global Financial Crisis (GFC), Australia has largely been beholden to the four major banks, who have found themselves overweight in property debt. When combined with the requirement to hold more tier-one capital to support property debt, they are unable to lend to the sector cost-effectively. Add to this economic uncertainty from the issues in Europe and it is easy for the banks to sit back and selectively allocate the available credit to only the best.
Traditionally when the big banks have stepped back from the property sector, the second tier and alternative market has stepped in to fill the void. With the GFC bringing an end to this secondary market, there is a significant gap, which is now being filled by foreign investors. Offshore private equity funds, sovereign wealth funds, pension funds, opportunistic funds and large private investors are all eyeing Australia as providing great opportunities for opportunistic style development returns in a relatively safe, transparent and sophisticated market. Initially, this money was coming in to satisfy mezzanine debt requirements of property developers, particularly in the residential market. However, the big four banks with their monopoly on senior debt have almost closed the door on mezzanine lenders by refusing to accept inter-creditor agreements or second-ranking securities behind their senior positions.
This is leading to a new breed of investor, which is prepared to co-invest through joint venture agreements, development agreements or even unsecured junior debt positions and more often than not, a combination of all of the above. This is lifting the risk profile of investment, but also enhancing returns for those prepared to enter the market.
With traditional Australian property developers being highly geared, the new credit environment means that there is ample opportunity for quality offshore investors. Generally, investors are coming in late in the development cycle, after planning approvals have been obtained, the project has been substantially or wholly pre-sold, the construction contract is in place and the senior debt arranged. An investor undertaking a thorough due diligence is therefore able to fully analyse the risks from the project and the likely returns.
As most investors are effectively acting in the role of junior lender, the bulk of the returns are usually able to be repatriated, subject only to the 10% withholding tax rate applicable to interest income. This ensures that the effective Australian tax rate on the investment is suitably low.
Recent volatility in exchange rates has impacted swap rate margins, however, with the United States indicating it will be maintaining its low interest rate policies until 2014 and the extent of the resources boom in Australia, it would seem that Australia's exchange rate is likely to remain high for the medium term, so many investors can factor that risk into their overall returns.
Residential development is not the only sector that is seeing offshore investment. The January Office Market Report indicated that sales of commercial property assets over $10 million were $5.6 billion in 2011, exceeding the pre-GFC total of $5.5 billion in 2007. Of these, 36% (just over $2 billion worth) of all CBD deals and 50% of all deals in Sydney and Melbourne combined were with offshore buyers (Knight Frank Office Market Report, January 2012).
This investment is being driven by strong office market fundamentals. While Sydney's vacancy rate at the end of 2011 remained at 9.6%, Melbourne's was a low 5.3%, Brisbane 6.2% and Perth only 3.3%. The net absorption in Brisbane and Perth was approximately 50,000 square metres each for H2 of 2011, being well above the long-term average and demonstrating the impact of continual growth by the resources sector and their suppliers in those markets. Whilst a significant 800,000 square metres of new stock has to be added in 2012, which is higher than the historic average, only 400,000 square metres will come on line in 2013 so that the two-year figure is in line with the long-term average. Very little of this supply is in the core Sydney market, with no significant new buildings to be completed over those years (Property Council of Australia's Office Market Report, January 2012).
With the scarcity of bank debt and the ongoing credit squeeze, the field is ripe for well-funded offshore players in the Australian market.
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