What is the best location for a residential development?

Last week I highlighted how it is impossible to overlook the key influence of location in the project DNA of any development.

Here in a recent conversation with one of my associates, Shane Dargue, from Colliers International in Melbourne, we will explore this topic in greater detail. From the outset I think it is clear that taking a site to market is a complex subject. topics like planning and infrastructure are never out of sight.

Thinking of a location as a blank canvas immediately opens the way for creative thinking so that one day the final development will deliver the very best result, and this is, I think, the core challenge this subject will explore. Recently in both NSW and Victoria the major land delivery agencies have been facing evolving roles as a result of shifting market pressures and dynamics, and I think this further underlines how complex a market this is.

Where are the demand hotspots?

Starting our conversation, I firstly wanted to know from Shane his take on the current demand for residential development sites and then moving onto what he believes are the key marketing challenges for new medium and high-density sites.

“This a big topic, but there are some common factors across most markets. But firstly we need to step back a few years, just to get a common starting point.

“Until 2010 across almost all markets there was what I would without reservation describe as an environment of fever pitch activity, and in particular in Melbourne. Then over the past few years 2011-12 there has been a shift in demand for sites. We have come of the highs of 2010 but clearly sites are still being sold, still in demand.

“The dynamics have moved to where the development risk has taken on a different complexion, and as might be expected it is access to finance that has come into much sharper focus."

To better help overview market conditions Shane suggests that it is helpful to look at markets across three main sectors, all of which will be familiar.

“I think that it is both helpful and necessary to look at the market for new sites as they fit into three distinctive zones. While they will have common factors in any major metropolitan market, for ease of discussion let’s call the three main markets A, B and C.”

Within this definition suggested by Shane the zones cover: ‘A’ the core CBD, ‘B’ the inner ring of well-established suburbs and our final group ‘C’, which covers the outer ring of suburbs where the majority of broadacre and greenfield sites are located. All three markets have locations suitable for medium-density development but are very different with varied fortunes.

“The CBD in any market always has the highest site costs, and beyond that the entire cost structure implies a major investment in terms of finance, time and marketing, its often seen as the most speculative.

“Then we have the inner ring of suburbs ‘B’ which is the more diverse and flexible of the three markets and in the case of Melbourne, because of Melbourne’s grid layout, it’s a rich source of sites.

“Finally we have the outer ring locations ‘C’, which includes greenfield sites, some locations are self-contained medium-density sites, which are usually in the more established areas while other are a part of a master-planned community estate. This is a market dominated by individual homes and is very cost driven, price and supply sensitive but still there are valuable medium-density sites.

"Demand for the outer ring this market has softened the most over the past 24 months and in particular over the past 12 months, partly as direct result of many more new homes coming into play as supply across Melbourne has increased."

The layers of interconnection

The outer-ring sites are the most price driven and so rely to a greater extent upon the growth of house prices and sales rates, in particular across the inner-ring suburbs and across the wider housing market generally but also to a lesser extent in the CBD. And so in this way the outer limits of the market reflect the wider health of the economy and so to varied degrees all of the markets are interrelated.

“If the economy is weak then people will tend to stay put in established homes, and at the pointy end of rental demand the CBD rental market can be impacted if unemployment becomes an issue, which then has a flow onto investor take-up.

“Also in the outer ring I have to acknowledge that the demand for sites is limited to some degree because this is also an area where medium density is a secondary market for buyers. Still for some budget driven buyers a townhouse in these areas is an appealing option, and profitable for the developer looking to defray site costs."

While the demand for outer ring sites has declined over the past two years, it has been the more stable buyer profiles for end-product in the CBD and inner-ring locations that has helped to create continued interest in sites.

“CBD and inner-ring development sites offer diverse locations and infill sites in particular have many positive traits. And that includes access to existing infrastructure that can be very diverse with a depth of social appeal, Footscray in Melbourne is an example I mention now and will return to later."

The pressure of finance a important influence

Shane rightly points out the reality that some or indeed most banks are now applying pressure when dealing with their development clients. But Shane also highlights that there have not been very many forced sales of development sites and prices for end product have been stable within areas of logical and typical development supply.

“The role of finance post GFC is now more magnified, and the IMF has also highlighted how much exposure the 4 major banks have tied up in residential mortgages and so caution is the order of the day.

“When we look at individual greenfield sites they have either been shelved because the capital tied up is less or their raw land values have decreased substantially where the rates of sales have slowed most. There is also usually little speculative building and better return on capital performance, which can be in stark contrast to the level of exposure associated with a medium or high density project.

“However, despite the financial pressures demand is currently strongest across the inner ring suburbs, these same areas are also very popular with end-buyers where owner occupiers dominate demand, but investors are also active. In the CBD there tends to be a bigger percentage of investors and in many cases an off-shore buyer with a long-term view of the market, which then helps underpin the demand for quality development sites.

We did highlight earlier that in the CBD the investment required for a major project outweighed the costs associated with other locations. The dynamics are very different attracting the bulk of high-end professional development, and for other developers this fact then shifts their focus to the inner ring suburbs.

“The inner ring locations are very popular and there is a pool of local developers keen on these sites. And so demand is mixed and there are more players looking for opportunities. While finance is still an issue we are dealing with local developers who know the market and work within a comfortable level of risk and capital/development."

At this stage of our topic it is the various risk profiles that have the most impact on the demand for sites. The risk profiles are also very dynamic across all three markets, still there are many other influences to take into consideration, which we will continue to explore and welcome your thoughts.

Peter Chittenden is managing director for residential of Colliers International.