27th Jul 2017

Small Scale Residential Development Melbourne

The property market in metropolitan Melbourne has been very strong over recent years, driving underlying land values higher than ever before, and creating a larger number of properties with highest and best use for development.

Melbourne continues to grow with around 3% (140,000) population growth in 2016. With such consistently strong growth in population, comes increased demand for all types of housing, which in turn creates challenges in town planning to balance urban sprawl against higher density development through the existing urban framework.

With zoning designation changes in 2014 across metropolitan Melbourne and continued loosening of development restrictions within the zoning schedules, we see an increased number of once “single residential use” properties, now becoming viable development sites, in particular through infrastructure nodes and activity centres.

Small scale residential development in Melbourne has become a more popular task for first timers than ever before. LMW have undertaken numerous residential development valuations over the past 12 months, and as such have some very interesting insights.

The majority of “as if complete” small scale residential developments analysed, have resulted in a project related site value lower than the underlying site value supported by sales evidence. Our development analysis shows the individual projects will result in less or no profit to the developer than historically has been the case.

We believe a lot of the projects which result in reduced or no analysed profit, are a result of a combination of, but not limited to: unsophisticated developers without real understandings of costs/risks associated with development who are paying excessive prices for sites, developers with in-house construction teams willing to forego builder margins, developers who intend on reducing or removing GST liability through differing holding/planning options, developers who bank on capital growth during construction process and developers who intend to hold one or more units for their own portfolios.

The small scale development market has been very strong since 2013/14 where the Melbourne residential market began the growth phase that still continues today. Development sites have seen very strong growth in capital values over this time and in many locations, growth levels of development site values, have out-stripped single residential property growth, resulting in generating less profit back to the developer when applying market parameters.

When the general market is strong, we see three levels of value for properties associated with small scale development:

1) The lowest tier of value should be applied to single residential use properties without any underlying development potential (e.g. Property with single dwelling covenant).

2) Second tier of value applied to properties associated with development potential only (appropriate zoning, little added value of existing improvements, suitable topography and size of allotment), which have not yet gained permits,

3) Finally the third tier of value associated with development sites with approved plans and permits where the proposed development is suitable for that property and location.

As an example of points 2 and 3, a street in Ashwood has had 4 sales within the last 3 months. The 3 sales analyse to $1,793 to $2,157/m² with development potential but not permitted. The fourth sale with permit for two dwellings sold for $2,269/m². In this case, the sales demonstrate a 5-10% increase in value for the permit being in place.

Added value for permits being in place is common from our analysis although not always guaranteed with all properties and locations.

Developers are generally more willing to pay higher value for sites with plans and permits in place where the permitted development is appropriate for that location and property and where development is clearly the highest and best use. Equally, if the planning permit is not suitable for the location, i.e. permitted for 15 apartments where the cost vs gross realisation of individual unit values on completion is less than required to create a viable development and where the site would be more suited to three townhouse development, then the permit should not add value over and above the underlying site value with potential only.

Developers will also require appropriate length of time left before the expiry of the permit to get appropriate funding and get the development off the ground, although generally, councils have been willing to extend the life of the permit over recent years.

Historically during strong times, development sites can outperform the rest of the property market, however, the exact opposite is true in a down turning market.

Any premiums associated with plans and permits or even for development potential, are usually reduced back to single residential use value levels as developers pull out from typical site acquisition during a falling market. With dramatically reduced demand for the “development value”, the development sites are more heavily impacted than the rest of the market in a time of poor market conditions.

We also have seen that developers face increasing settlement risk as purchasers of property “off the plan” are facing increased funding restrictions and taxation with: off the plan purchase stamp duty savings for Australian residents now eliminated with duty paid on total property price rather than land component only. Also non-Australian residents have increased stamp duty costs over and above previous levels. This is somewhat countered by the recent first home owners in the sub $750,000 range now eligible for at least partial stamp duty reductions, and full abolishment in the sub $600,000 bracket. 

It is always easier to make profit in development when the market continues to grow. Without a crystal ball, it is difficult to know when a good time to develop is. Simple changes to planning, design, construction and timing can dramatically affect your ability to achieve success. Ensuring the feasibility is correct from the start, is the most important step.

Please contact the LMW team who can provide advice on a wide variety of property services including residential development feasibility consultations and/or valuations.

Nick Funnell

State Residential Director - VIC

Nick is LMW's State Residential Director in Victoria and specialises in residential, prestige residential and low scale residential development valuat…

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