For the last couple of years, there has been a clamour by most opposition political parties for the government to do something about the rampaging Auckland housing prices.

Either in response to that or in cognisance of the looming election, the government released a National Policy Statement (NPS) last week on the provision of housing within New Zealand. It did, of course, focus on the Auckland market as it is by far the most problematic. The Auckland region average price for a house is now $872,000, around nine to 10 times the average income, depending upon the sub region. With the World Bank recommendation of affordability sitting at a three times income multiplier, this is a significant issue that shows no signs of abating.

The Auckland problem stems from basic Keynesian economics, demand outstripping supply, and the government’s answer in the form of the NPS is to order the Auckland City Council to increase supply. They haven’t provided any real sanctions should this not be achieved and simply fail to recognise that providing land is only a part of the solution.

The various opposition parties have criticised the proposed solution, claiming it fails to address the cost of providing the infrastructure, and while no doubt somewhere within the breadth of those seeking to supply the solution and those critical of it, there must be intelligent life, none of them seem to have understood the basic requirement that is key to even beginning to solve this problem.

The main component of this mix is the developer. I know, I am one and whilst it is not the ‘magic bullet’ it is very much the start. Developers, clients, call them what you will, are the top of the food chain. Without them, nothing happens. They/we pay all bills, from council consent to services connections to sales agent and lawyer fees and titling costs. It is we who take the risk of making the scheme work, employ tradesmen and engage suppliers, give personal guarantees to banks and put ourselves in debt. We embody the principle of the basics of commerce, taking risk for reward.

It doesn’t really matter how many acres of land the government makes availabl. Until they can somehow soften the risks as outlined here, that pertain to even a modest development, the demand/supply imbalance will continue.

The first consideration from a development perspective is the raw commodity, land. Land cost is a tide that floats all boats. It shouldn’t matter whether you buy in the most expensive area or the cheapest (all other things being equal) the more you pay for land, the more you should obtain in profit and yes, I know that is a broad generality and it is only ‘broadly’ true.

Having sourced the land, for most developers in the, roughly $1 million to $4 million bracket, development is a two stage process for reasons that will become apparent later.

Stage 1: Land is purchased, a topographic survey undertaken, feasibility study completed and a geotechnical investigation carried out. From that, an off-plan valuation is procured and a resource consent (more than three units is the trigger in Christchurch) is applied for.

Stage 2: Once resource consent is granted, that with the valuation can be taken to the bank and, hopefully, the build funding can be advanced.

Here’s a brief overview of a current scheme in Christchurch I have knowledge of: the site has gained resource consent for nine units; three two-bedroom apartments, two one-bedroom houses, three two-bedroom townhouses and one one-bedroom house. The total developable floor area is 836 square metres, (gross external). At $280,000, the cost of the land per unit is an average of $31,000.  The end valuation of those units is $3.03 million. On the face of it, it looks healthy, but let’s examine the costs in detail.

There are a number of slices taken away from this particular pie at various stages throughout the project and it is important to note that from beginning to end, a development of this size is likely to take around 18 months.

The first slice is the land, which comes in at $280,000. Then, you get into feasibility, developed design, topo, geotech, resource consent and legal fees, adding another $40,000.

Detailed design adds $50,000, building consent another $8,000, the build cost ($2,200 per square metre multiplied by 836 square metres another $50,000. Add $55,000 for contingency, $6,000 for interest, $20,000 for code compliance and titling costs, $140,000 for the development contribution to the council, and $75,000 in sales agents’ fees and you get a total of $2.54 million. GST (excluding land) brings that number to $2.9 million.

With a total revenue of $3.03 million, the net profit is only in the order of about $134,000, or 4.4 per cent of the cost.

This is currently a very realistic portrayal of the economics of a development, at least in Christchurch. I have little doubt that other parts of the country are similar.  To my mind, to even consider taking a $2.9 million risk for a return of $134,000 ludicrous. Yes, I know that is well above the average salary, but it is precisely that – a salary earned over 18 months.

The individual earning it does not in any way expose themselves to the risks that undertaking a development such as this entails. That salary is paid almost risk-free to the recipient.

Personally, I wouldn’t undertake a scheme that returns less than 15 per cent profit on cost. It is simply not worth it and perhaps more importantly, most banks have the same view. This is where the NPS and the government and opposition seem to have blinkers on. Unless this risk profile changes, development will stagnate.

The lending criteria for one major bank here (and this is typical) for $1 million-plus developments, is that they will lend no more than 65 per cent of the value of the scheme (so LTV ratio is 65 per cent). And here’s the rub: they will then only advance the build cost if the developer achieves 100 per cent pre-sales.

There are three difficulties with this. One is the LTV ratio; in the above scheme that requires $1 million cash or equity.

Second, the achievement of 100 per cent pre-sales is difficult and can take months, if it can be done at all. In so doing, the developer is likely to have to discount the sales price given the sale is ‘off plan’ and further, the deposits are no aid to cash flow as they sit in a trust account.

The third problem is the consequence of this policy; to embrace this means the following:

  • The site is purchased, topo, geotech undertaken, developed design completed and resource consent is obtained.
  • A sales agent is engaged, renderings completed and the units marketed. Detailed design can be progressed at risk, or deferred.
  • Following the marketing exercise, if for example only 70 per cent of pre-sales can be achieved, the bank will not advance the build cost leaving the developer having bought the land, expended design and consenting costs and left having to renege on pre-sales (reputation forever sullied) and stuck with a site that with luck may be on-sold to cover costs and perhaps a little profit. It may also make a loss.

This is the development reality for many.

More land does not necessarily equal more development. It is not that simple.

The UK, to cope with growth, nominated a number of areas of land to become ‘new towns.’ The biggest and probably best known is Milton Keynes. The infrastructure – not just roads, but parks, lakes, cycle paths, bridleways, ponds, woods, over and under bridges, picnic areas and so on – were all government funded. Sections were reasonably priced, fenced, titled and came with outline planning permission (very similar to resource consent) and services laid to the boundary. Within the section was a footprint and some basic design guidelines that constrained building, but not by much.

This approach ‘enables’ the land. It provides both bank and individuals with some certainty, and reduces the cost and the time that goes with development. The government could, should it wish to, ‘gift’ the land initially, taking the land value when profit is realised, something that would greatly encourage and enable developers and no doubt put smiles on the faces of the banks. This could be controlled by covenants and legal agreements, step-in rights and guarantees, particularly on completion.

This is the type of broader thinking the NZ government needs to bring to bear and whilst it is of itself not a complete solution, it would go a long way toward increasing the supply and the ‘time to market’ and reducing the risk that goes with it.

The other major hurdle at the $1 million-plus level is the bank’s lending criteria. If they cannot be less risk averse in what is generally in NZ a rising market, it is worrying to consider how tight lending might be when the market flattens and the effect that this may.

A final word on the major component of the above costs; the build figure. The build cost is on a ‘gross external area’ basis, with the sales costs per square metre on a ‘net internal area’ basis. The unrecoverable difference, which can be around 12 per cent, does not help matters.

That figure quoted of $2,200 per square metre is on the low side in Christchurch and would be difficult to achieve and any higher figure, only makes things harder.

That in reality makes almost any development site on the market unfeasible and explains the relative lack of development that I see (or rather don’t see) in Christchurch at the moment.  It also goes some way to explaining why beating the Auckland Council with a big policy stick is not going to do much to remedy the situation.