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Entering a new financial year is a great time to take stock of performance over the previous year and calibrate some models for what lies ahead. If you are a developer that operates within the NSW Growth Centres (north west in particular) we hope you obtained as many DA approved lots as possible prior to June 30 and locked in your capped S7.11 contributions.
It is worth reiterating that July 1, 2020 is an important date. The cost of development in the Growth Centres due to local and state contributions, as most of us are aware, is set to increase significantly due to mandated increases and changes to the current system. To mitigate the effect of these increases, developers will need to adjust their strategies or risk a fall in profits in an already challenging market.
The Background
The stage for new homes to be constructed in greenfield areas has been set in the north and south west growth precincts of Sydney. As part of this, the State Government has mandated contributions to support the greater infrastructure needs of the expanding population. These come in the form of the S7.11 contributions. Until July 1, 2020, these will be capped in transitional areas.
This is important as historically, the relationship between profit and yield was generally relatively linear. The more lots/dwellings, the more revenue (and, hopefully, the more profit). However, that cap is being removed from July 1, 2020. This means profit optimisation may no longer be as simple as maximising the yield across your project.
Governing Factors
In the growth centres, the SEPP 2006 zoning and relevant DCP provides criteria to determine the size of each residential lot. Capped S7.11 contributions have historically encouraged developers to create the maximum number of lots within a residential-zoned area. This meant the SEPP and DCP constraints were, when the market was at its peak, the primary determining factor in the subdivision design of a site.
Fast forward to 2020. ‘Uncapped’ contributions mean this may no longer be the simplest strategy to optimise the profitability of a residential land development project.
Do the Maths!
The following simplified models help to explain the new relationships. We have a set a few key inputs as listed below:
- We have assumed a standard 2.25-hectare site that has a 75% net area for production of residential low-density lots i.e. 16,700 sq.m is available to sell.
- Englobo land acquisition costs were set at $1.5M per acre or $371 per sq.m.
- Revenue per square metre is adjusted depending on the number of lots produced (relative to the average lot size):
- Development costs: Establishment, roads, earthworks, sewer and water reticulation, and authority costs, excluding S7.11 contributions, are set at a flat rate.
Service connections, electrical and NBN reticulation, and design are associated with a per lot cost resulting in varying costs depending on the number of lots being produced. - SIC is applied based on developable area ie. 2.25 hectares in this instance.
- CPI, Interest, financing, marketing and legal costs have been excluded as these vary depending on the developer’s structure and time taken to complete a project.
Considering the above and applying the assumed revenue costs to the same development with varying S7.11 contribution rates produces the following scenarios:
As you can see from the above scenarios, the new profit ‘sweet spot’ is different to the maximum yield when increasing contributions from $40k per lot. In other words, higher contributions break the historical linear relationship between maximising profits and maximising dwellings.
Generally Speaking
At the $40,000 contribution rate, revenue is protected from diminishing returns – the greater the yield, the greater the profit.
A similar scenario occurs with S7.11 rates at $60,000 per lot. Profits continue to grow from 35 to 45 lots, however incremental increase in profits become much less at the higher yield, offering under $4,500 for the additional 45th lot.
At the $80,000 rate, we see a different pattern, with development in excess of 42 lots resulting in diminishing returns. In this example, the creation of 45 lots would result in a loss of $52,527! In a challenging market where sales rates are low, producing those additional lots does not appear to stack up.
The below graph demonstrates the relationship of profit vs production of lots and for Scenario 3 – $80,000 S7.11 per lot. The graph demonstrates that the rate of profit maximisation reduces when more lots are added.
Comparatively, graphing the $40,000/lot Scenario #1 produces a more linear increase over the same lot yield as seen below:
State Special Infrastructure Contributions (SIC)
To add to the complexity, the State Government has indicated that in the not too distant future SIC will be levied on the number of lots generated in the North West rather than on the per developable area that it currently is.
It’s our opinion that the impact of the uncapped S7.11 contributions on development profit may be magnified by the Special Infrastructure Contributions (SIC) levy that developers may be required to pay to the State Government on a per lot basis. This change will further exacerbate diminishing returns as an estimated cost of $15,500 per-lot will apply to each residential development (proposed north west SIC). To win in the ‘uncapped’ 2020 landscape, developers will have to carefully calculate their best option. It will no longer be dictated by the subdivision criteria provided by the respective SEPP and DCP.
What can you do?
The uncapped contributions era will create new challenges for developers. There are several things you can to do to reduce the impact of the change.
- Check your numbers early
Ensure you have determined the yield that maximises profit under the new regulations and contributions schemes when doing your due diligence. Remember, less may now be more! - Get design smart
Under the old rules, poor design often went unpunished on the bottom line! From 2020, you’ll need to ensure you make the most of creative solutions to minimise inefficient subdivision layouts. A good understanding of the planning requirements that has a direct impact on the ‘numbers’ is crucial. A balanced model of good planning and easy approvals is often another key determining source of success - Sell your story
Developing innovative ways to differentiate yourself from competitors will be even more important in a tightening market. Get clear on what you do well for your target customers and make sure you are telling your story in a way that connects.
Whilst there are many factors that contribute to land development profitability, the uncapped contributions rates present a new challenge for Sydney’s residential subdivision market. Making sure you are across the detail and have a clear strategy will be vital to success.
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