Falling land values open new doors

17:00, Aug 25 2012

Falling values on some major development projects are creating opportunities for a new wave of developers, according to Ray White Commercial.

A report on development land in Auckland by Ray White Commercial property analyst Brendan Keenan casts doubt on whether some of the huge development projects that went belly up in the aftermath of the global financial crisis ever had a realistic chance of success.

Keenan said the massive Albany City project on Auckland's North Shore was a good example of a project where developers' ambitions raced ahead of market realities.

"In Albany, a 127-hectare lot of rural land was purchased in 1994 by the Neil Group from the Housing Corporation for $21 million, or $16 per square metre. Ten years later Neil Group sold 44ha of the site to Cornerstone Group for $250m [$560 per sqm], nearly 35 times Neil's original purchase price.

"In 2006 Cornerstone created a leasehold layer over the site, and sold the ground lessee's interest for over $100m [$227 persqm].

"By this time Cornerstone's interest in the freehold layer was valued at close to $325m [$738 per sqm], a staggering $75m increase in value in less than two years, with large portions of the property valued in excess of $1200 per sqm."


Around $500m of development projects were planned for the Albany site by various leaseholders with interests in the property, which was tipped to become an alternative business hub to downtown Auckland's CBD.

So by the time the global financial crisis hit, the total value of the land (freehold and leasehold) was supposedly around $425m, at least on paper.

But was it ever really worth that much? Probably not.

Keenan said the valuations that supported such ambitious proposals were usually undertaken on a "residual value" basis.

That is where a developer works out a property's maximum development potential, that is, how many offices, shops, apartments or whatever could possibly be developed on the site, estimates their total sell-down value, probably at optimistic prices, and then works out the land's value at the end of that process.

Another way of looking at such valuations would be as an act of faith, built on a platform of hope on a base of irrational exuberance.

According to Keenan, what was missing from such calculations were realistic assessments of market demand for the squillions of square metres of floor space proposed for such projects and the prices people would likely be prepared to pay. And all of this was made possible by the willingness of banks and finance companies to pump tankerloads of money into such schemes.

"Let off the leash, master planners and architects began drafting up ambitious schemes to transform sites around the city into developments which would have been considered large even in a city like Sydney or Melbourne," Keenan said in his report.

"On paper, high-rise towers began springing up along the city's urban limit and massive mixed-use schemes with floor areas rivalling even the largest CBD office towers, were planned for the the city's fringe.

"From the start of 2006 until to the end of 2007, land values in many areas across the city increased 20-50 per cent, disguised by easy credit rather than reflections of underlying supply and demand."

As well as Albany City, other projects were based on similarly optimistic projections were the Soho Square development in Ponsonby and the Rhubarb Lane site near Victoria Park.

As the finance companies that supplied developers of such projects with their second-tier lending began to fail, the projects started falling like dominoes.

"With liquidity gone and the economy sliding into recession, projects around the country ground to a halt," Keenan said in his report.

"Sites like Soho Square and Rhubarb Lane quickly became huge liabilities for prime and secondary lenders owed hundreds of millions of dollars in non-performing loans.

"Land values for vacant development sites around the city began to slide backwards as secured creditors and their receivers took control of projects, wiping out mezzanine funders and unsecured creditors."

When projects were put on the market as their funders tried to recover their money, the potential buyers kicking the tyres realised the properties could only support far more modest developments, which reduced the prices they were prepared to pay accordingly.

According to Keenan, one example of the dramatic slide in value was the 1264sqm development site at 35 Albert St in Auckland's CBD which was sold for $12.25m in 2007 ($9864 per sqm) then resold in 2009 for $7.256m ($5736 per sqm), a 41 per cent loss.

The losses on other sites, such as Rhubarb Lane and Albany City, were believed to be even greater. Rhubarb Lane was supposed to end up as a billion dollar mixed-use development, but when it was put back on the market it sold so cheaply it was able to be bought by its main tenant for ongoing use of the undeveloped land as a public car park.

According to Keenan, there is plenty of upside for the buyers of these properties.

Apart from the fact they are buying attractive development sites at much lower costs than their predecessors, and have more realistic expectations about what will be feasible to build on them, another major benefit is that much of the initial development work has already been done.

That can range from gaining the necessary resource consents, often a costly and time-consuming process, to putting infrastructure such as roads and utilities in place.

Keenan said Soho Square was a good example of the more modest aspirations of the new breed of buyers. The original plan called for a large-scale residential and commercial development to be built over a huge underground car park.

That's now been scaled back to a more realistic mixed use project incorporating a supermarket.

Sunday Star Times