Gold tape?

A few weeks back Prosper Australia released a report entitled Staged Releases: Peering Behind the Land Supply Curtain.

The report has attracted plenty of media interest.

It short this report blames developers for holding up land supply in order to keep their end prices high making them the major reason behind low affordability when it comes to buying a new home across Australia.

Forget red or green tape, developers hold supply behind a gold tape: they must ensure there is not enough supply to push prices down.

The report goes on to say that say that government makes available a large amount of land by rezoning and fast-tracking approvals, but the decision is then left to the development company about the rate at which this land supply will be made available.

So, a lot of them are drip-feeding land out in order to keep land prices high.

Many pundits added their voice to this malarkey with a few even stating that this control over supply and price would be seen as anti-competitive behaviour in any other industry.

Sadly, too many housing development related institutions pleaded the fifth when asked about this work rather than offering a reasoned argument.

Well, given this vacuum here is my reply.

I offer several observations.

One, the authors appear to have no idea how the development industry works.

Many suppliers of new housing across Australia are private businesses, with the largest providers – in terms of the number of new homes built – are publicly listed developers/builders.

A business by definition is a vehicle for profit.  Owners and shareholders demand a return on their investment.  And the few public land agencies that operate in this country function in exactly the same way as those in the private development realm.

Two, the Prosper Australia analysis doesn’t examine the market share of the projects in question, merely their individual sales rates, which is a function of their competitive position.

In competitive markets, like in most of the major urban growth corridors across Australia, even large developers can’t set prices by restricting land sales.  Their prices are generally cost of production plus a margin.  Typically, this margin is between 15% and 20%, resulting in profits – in general and across a property cycle – of between 8% and 10%.

Frankly developer’s undertake a lot of risk for their return.  And not every year provides a profit.

The Prosper Australia analysis doesn’t seem to recognise how competitive the land market is.  Even the largest projects in an urban growth corridor would struggle to get much above 25% market share.  Most projects range between 5% and 8%.

These low market shares don’t equate to price setting power.

Also, no business would drop their prices to keep demand high especially if that price drop would mean little or no profit.

Three, the cost of capital to most developers is much higher than land price escalation, so all unsold lots are a drag on balance sheets, not a benefit.

Accordingly, developers build and sell as fast as they can, i.e., as fast as the market will bear.  This is a function of the number of consumers in market at any one time, and their choice of where to buy, based on their capacity to pay and the prices of different products.

Our recent work for two major listed land developers active across half a dozen urban growth corridors across the country, suggests an annual land price increase on a rate per square metre basis of between 2% and 4% between fiscal 2023 and 2025.

Yet most of the larger developers need an annual increase of at least 10% in land values to keep their projects viable, once you factor in all associated costs plus interest.

Four, there are capacity constraints to production.

Even where demand is going gangbusters, the most a project can generally produce is around 500 dwellings or lots per annum, although there have been a few examples in Australia of large master planned estates doing between 800 and 1,000 lots in a year.

But when this happens infrastructure supply lags resulting in further delays and often increasing development costs.

Five, a ‘approved’ at zoning doesn’t equate to ‘immediately developable’.

Other permits and approvals are required before subdivision and construction, by multiple authorities many of which have their own capacity constraints.

Red and green tape are largely to blame here, not gold.

Six, the process of converting fields to housing is such a lengthy one (often taking in excess of ten years) that the many larger developers are obliged to create long-term land banks to be confident their businesses are sustainable in the future.

The major home providers in Australia need to produce, on average, between 2,500 and 5,000 new lots per annum; so, need large stocks of land – much of which might be zoned for urban development but not yet approved for subdivision/construction – to guarantee future supply.

And it can take many more years to get land zoned urban to be approved for subdivision/construction.

Seven, the cost base of new housing land is way too high.

There are many things in play here.

The first is that the cost of raw land is high, rising and it’s supply is finite.

Urban growth boundaries, urban footprints and the like are much smaller than the many authorities think.  This is due to topographical and environmental constraints, servicing sequences and land fragmentation.

Because the supply is limited in every corridor, landowners are in a price setting market and can simply hold out until they get the price they want.

It is little wonder that some developers, especially those with deeper pockets, buy raw land when the can and when that price is right.

Another factor impacting cost is the price of urban infrastructure which is now all funded upfront rather than over the lifecycle of the asset.

Also having a big impact are government fees and charges which often make up for over 40% of the cost of a new allotment.

One could also argue that development standards are too high these days and the hoops that developers are made to jump through are increasing complex, divergent and inconsistent.

Finally, once land prices go up, they rarely go down, though it does sometimes happen.

This is because input costs also generally go up when land prices go up.  Even if a developer has already secured the land, all of the other input costs will go up as prices increase due to prevailing economic conditions.

And in long-term land management agreements where land payment is tied to land price, it goes up automatically.

Developers also don’t like discounting land below past prices as it undermines consumer confidence.  Doing such leads to lower market share and fewer sales.

Besides I have never heard of a homeowner wanting to see their value of their land and dwelling fall.

Maybe taxing farmers and other (non-developing) holders of raw land would assist, rather than Prosper Australia’s plan to tax developers for not selling fast enough!

PS The Victoria branch of the UDIA did post a op ed in The Age in response to the front page spread that paper ran on the Prosper Australia’s report.  Go here to read the op ed.

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