Margin Squeeze

Margin Squeeze
Why it's Happening Whether You Know it or Not

by Sebastian Muscolino - SPS Group

I keep hearing it ... the site doesn't stack up. Well it's true, very few sites at present are financially viable and there are a multitude of reasons why. Of course it depends on what market segment we're referring to (as there are exceptions) but a lot of Brisbane's Inner Residential City sites can't make money in the current climate.

The concept of Margin Squeeze (an increase in costs and decrease in sales prices) is not new - it happens when the champagne bubbles start to fizz ... land values are unrealistic, funding gets tight, contractors raise their prices - all at the same time when sales rates start to come off and prices soften. It's when the excesses of supply come back to bite us, and right now it's a reality.

It's quite simple - Sites are too expensive. Land owners within the South-East's Inner City have become increasingly educated in the development space - most now understand what can and can't be developed on their land and, as you'd expect, their taking advantage of it. Of course, they don't understand the layering of development costs and don't prepare hypothetical residual feasibility studies to determine a fair value - rather they work on a cost per box, preached to them by their local real estate agent (most who aren't familiar with development valuations). Having said that - I get it ... "they're not making any more of the stuff", so if you own development land - the Golden Rule applies.

Then there's the financier. They say they're open for business but in truth, credit is tough with most bankers now re-balancing their portfolios, away from development risk (and some away from property all together). Their response is predictable - they want (need) to see pre-sales of around 100% debt cover. Looking ahead, this is unlikely to change until the current negative sentiment and current (cyclical) over-supply is absorbed. Simply put, there is currently little appetite for development funding, at least from the mainstream lenders.

Building prices have been rising now for some time now - this has caught out most by surprise - the bad news is there's not much you can do. Of course there are some innovative procurement methods that can mitigate some cost increases, but the reality is when tradies are in short supply (typically pulled to larger projects) and supplier collusion is in full swing, you'll lose out. Rising prices usually have the most notable adverse impact on your feaso!

On top of these, sales rates are slow (some segments are at a stand-still) and sale prices are also under pressure - the classic over-supply. Consumer confidence plays a part but simply having too much of the same stock doesn't help.

So, moving forward, what's the answer? Well, land banking is an obvious strategy but you'll need a good balance sheet and a healthy cash flow from another source. Even though interest rates are low, financiers aren't keen on land banking. If you can afford to land bank then I'm all for it!

One alternative solution is to apply value management techniques at the design development stage - creating a product that meets a specific, niche market segment which aggressively explores cost alternatives at all phases of the process.

About Author

Sebastian Muscolino

Sebastian has 36 years in the property industry and an extensive range of experience in Property Development and Building Construction having being in involved in all aspects of the procurement and delivery process for both small and large commercial retail, residential, office and industrial projects across Australia.

SPS - Synergy Property Solutions

Location:  Graceville, Brisbane

SPS Group

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