Chris Wu – Equity Analyst, Macquarie Investment Management
Wednesday 23 November 2016
Has the Aussie apartment market gone off-plan?
Chris Wu – Equity Analyst, Macquarie Investment Management
The Australian apartment market has been the subject of much speculation recently. Questions of oversupply have hung over the market as the number of under construction apartments has rocketed. This oversupply potentially paints a negative outlook for property developers, with oversupplied markets tending to experience falling prices and profits.
Rolling twelve months commencements excluding houses
Source: ABS, June 2016 (dwellings excluding houses)
But the headline statistic doesn’t tell the whole story. In this article we discuss the risks of an oversupplied apartment market and assess how listed developers are positioned to deal with apartment development risk in the coming years.
Listed developers vs private developers
1. Pre selling and diversification
Lendlease and Mirvac are the largest listed companies in the residential development industry. Almost 90% of their apartments due to settle in the next three years have ‘exchanged contracts’. This means the apartment buyer has paid a 10-15% deposit (and potentially stamp duty), and is contractually committed to the purchase. Settlement of the remaining sale price is expected to be paid upon development. This means that a buyer is financially incentivised to settle on the purchase, or risk losing the deposit. If the buyer reneges, the developer can resell the apartment, realising the full deposit taken from the previous buyer as profit. The high proportion of apartments that are pre-sold in this way, reduces settlement risk for listed developers.
We expect, Australian apartments will become an increasing share of Lendlease and Mirvac’s earnings going forward. However, as can be seen in chart two below, the Australian apartment segment is less than 20% of their respective group earnings. This translates to low overall earnings impact for their respective businesses, should apartment defaults become prevalent in the residential market.
FY16 operating earnings for Lendlease and Mirvac
(% Australian apartments)
Source: Macquarie Investment Management, Company Filings, August 2016
2. Quality and quantity
The residential development market is fragmented, with no one player owning more than 10% of supply due to be completed over the medium-term. The fragmented nature of the industry means that residential apartment products are not homogeneous – location, build quality and amenity offerings are key differentiating factors. Whilst an oversupplied market will put pressures on the average market pricing of apartments, Lendlease and Mirvac apartments should maintain a premium valuation given the higher quality of their developments relative to the market average.
3. Does scale matter?
Finally, the scale of listed developers means they are resourced across the delivery process to manage profitability better than smaller developers. Key advantages for listed developers include:
- Vetting buyers through internal sales teams, in contrast to distributing via agents – this allows listed developers to pre-sell supply to the right buyer groups. For example, both Lendlease and Mirvac target around 30% of foreign buyers to help manage settlement risk.
- Control of construction costs and time to completion – Mirvac disclosed in their FY16 results that ~70% of construction costs are secured prior to construction commencing. Lendlease employs an internal construction team to manage project timeframe and costs.
In contrast, unlisted developers may not have the scale or resources to ensure timely delivery and cost control. Listed developers that have access to these resources are often better placed to manage timeframes and margins on their development projects.
Conclusion – Navigating an oversupplied apartment market as a listed developer
With the current trajectory of apartment supply additions, the Australian apartment market looks to be heading toward oversupply going forward. We believe listed developers are better positioned to manage the risks of an oversupplied market given residential development is a smaller part of their overall businesses compared to smaller developers. Listed developers also employ a ‘masterplan’ approach which improves the quality of their apartment offerings and are resourced to manage both delivery and settlement risks in their projects.
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