Calculating the cost of the new Better Apartments Draft Design guidelines

The proposed apartment standards will add $62,500 to the construction cost of each apartment. The attached document below illustrates our calculations for each of the standards.

The cost of each standard is calculated by multiplying the construction rate with the increased area of each item. None of the standards are for free. They all come at a cost. The yield of each site will also decrease by 20% to 40% as a result, with the impact on potential development sites, profound.

Supply will reduce and if potential developments are to be unlocked, then the land component of each apartment will increase by $20,000 to $40,000. There are two indisputable requirements for property development: one, the land component of the development must be worth more than the existing building; and two, the development must make a profit otherwise the banks won't fund it.

Industry impact of the design standards

If a site is vacant, the land value will simply be reduced – bad for the land owners, yes, but for developers, this will have no impact. However, in Melbourne where the majority of developable sites require the demolition of a pre-existing building, (think every high street within a 5km radius of the CBD), then it is a completely different and far less positive story for the developer.

The proposed apartment standards call for enormous building separation, the extent of which makes many sites undevelopable. This means that whatever type of building currently exists on the site, it will remain – no matter how under-utilised it is.
The overall result? Less supply.

Think of it this way, if every site yields on average, a third less apartments, then there will obviously be a third less apartments on the market and therefore a far lesser supply in established areas. The by-product of this? The population will be pushed further and further out until it reaches the urban growth boundary where prices will increase due to the extra demand.

Supply and demand fluctuations

Of course, developers won't develop only to lose money. They will instead hold their land until such a time as demand becomes so high that the public is forced to pay the additional apartment price, at which point making the development profitable again. We saw this happen in Sydney, where many developers put their projects on hold for some years until the prices reached $15,000 a square metre and then were developed in a frenzy.

This means that as the apartment industry supply slows, prices will rise. Only once the public are willing to pay that extra $100,000 per apartment, will development take off again. It’s a scary truth, but a truth nonetheless.

The government is fully aware that their apartment standards come at a significant cost, but whether they decide to communicate this to the public is an entirely different matter – what do you think they will do?

Click here to see our calculations.

Above are images taken from Craig Yelland's/Plus Architecture's response to the Better Apartments Draft Standards as of 15th August, 2016.

This piece was written by Craig Yelland, Director of Plus Architecture – a firm with vast experience in the multi-residential sector, Craig Yelland is an advocate of apartment living and innovative design.

Lead image: Andrew Curtis Photography


Bilby's picture

This article is worthless spin, unless developers are willing to disclose their operating profit for given high and mid rise projects. You say a developer won't develop to make a loss, Craig - no argument there. But that is begging the question, isn't it?

Can you provide an example of a 2016 development in Melbourne, with the actual total profit figure after all costs are factored in to the developer? That would help to demonstrate the seriousness of your argument - i.e., will developers really be making a loss after the new standard are enacted, or simply making a lower margin profit?

Also, are you assuming that land costs are fixed, or do you accept that the market price for land will moderate in response to the lower yields projected in your article?

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Primal Beauty's picture

Totally agree with you bilby...just like banks; crying crocodile tears!
At the end it will be about demand and overall economy's state!

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theboynoodle's picture

@ Bilby

Land values will fall if apartments become more expensive to construct and all other things remain equal. Craig's argument is that this will mean that sites with a current use will become less compelling. This is true (a shop with a rental income of $60k might be worth $1.5m - so if the development values before the standards was $2m and now it's $1m, the owner won't sell the shop to a developer), but there are no figures here to illustrate the scale problem and with so much low-rise across the city, including swathes of the inner suburbs, I cannot believe that there will be a shortage of sites where the existing owner and a developer are not able to come to a profitable arrangement. And if there are, then the problem is with planning restrictions, not apartment standards, and the developers should be lobbying the government to zone more areas for apartment developments to make up for the lower number of dwellings that these standards will have on the current bank of sites.

As for developer margins, well I expect that they work backwards and have a required percentage yield from a project, partly driven by the requirements of those financing projects, and partly driven by their own desire to make profits. They'll have some scope to lower margins if these standards create a 'new normal', and financiers will have to accept that too - although, in both cases, if there are more compelling uses of capital elsewhere then those who are not tied to the local market may go elsewhere.

So if we go back to the 'work backwards' thing, it, again, comes back to whether landowners will accept lower prices for their sites.

I was actually quite please to read this article as opposed to previous ones where Craig has tried to make out that the cost of complying with standards will simply be passed on to buyers. this piece is much more economically literate. And he is right that if the effect of the standards is to reduce the number of dwellings constructed then *that* will have upwards pressure on prices over time. It is for the government that imposes the standards to recognise this risk and take the steps necessary to ensure that the number of dwellings delivered is in line with what's required given population expectations etc etc.

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Realist's picture

Developments must achieve minimum margins in order to secure bank funding; I am not aware of any developers who fund projects entirely from equity. The issue is not about developers margins.

The intent behind the new guidelines is positive and well intended, but, the commercial consequences have not been thought through. The effects of many of these new guidelines will indeed add cost, e.g. entire floors within towers devoted to storage lockers, it's not limited to the cost of the larger lockers Craig.) and of course these costs will be passed onto the end user.

Many of the suggested controls will improve design, but this is generally achieved via increasing the size of units. The nett effect of this will not simply be more expensive apartments per se but rather will restrict supply to larger and thus more expensive product; this will excluding entire demographics such as first time buyers.

However, the effect of elements of the new controls will be much more fundamental, rendering many development sites commercially unviable. Land values will stagnate, but not in the short term. I don't think supply will fall in the immediate term either as there are numerous projects already within the system, but there will be a slow down with supply at some stage.

Supply, restrictive price points (first time buyers and investors priced out of the market) and additional costs will all combine to effect the development industry and in turn the construction industry and all the other associated industries which feed from it.

Much of the proposed controls are positive but virtually all have a degree of 'wish list' about them. Rather than pose the question would you like these design guidelines applied to your apartment, perhaps the question is better posed as 'How much would you be willing to pay for an apartment built in accordance with this new guidelines.'

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Parsage's picture

Development margins, like any financial return, are based on risk: higher risk requires a higher potential margin. Development is no different. It is a highly competitive market and developers can, will, and do compete on margin as far as they can. Banks' appetites are relevant at the upper end of gearing limits, but will tolerate low margins if their position is well covered by higher equity.

This also goes to the government's unstated impression that developers make large profits that governments can plunder without having any effect on the market.The simplest economic analysis says this is not true. Barring barriers to entry, unjustifiably large margins will attract new entrants who will bid the margin down to the norm. The recent rash of new entrants demonstrates that there are no effective barriers to entry protecting high margins in this market.

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Adam Ford's picture

These numbers would only mean ANYTHING if they were applied to a SPECIFIC project that straddled the new regulations.
Otherwise you CANNOT erect a tower in 2020 under the new regulations and say "that cost me $X more than it would have". You can only do that if you were forced back to an ACTUAL drawing board by the design standards.
So yes, it's a competitive industry, and we compete on margin blah blah
There will be some more pressure on everyone's bottom line, sure, but only notionally. Developers will continue to cost projects individually and reconfigure those projects to maximise their profit. So the hypothetical 2020 tower will still arise, it will just look slightly different than what it would have before the regulations.
Meaning all of that bulldust about reduced supply side forcing up the overall price of developments is rubbish too. That's just one giant assumption turned into prophecy.

The actual factors in determining what a specific parcel of land sells for are SO weakly correlated to "supply" as a headline concept that they can and SHOULD be ignored here. And anybody who claims to be "industry" and peddles an article of this length containing that sort of sophistry is just asking for bulldust to be called on them.

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Nicholas Harrison's picture

The standards will reduce site yields. A reduction in site yields means that there will be less sites suitable for development and that a smaller number of apartments will be built on the sites that remain. In other words the supply of apartments in established areas will be reduced by the proposed standards.

A reduction in the supply of apartments in established areas will have an overall impact on the availability and affordability of dwellings in these areas.

Developers will not simply recue their margins, they will look for opportunities in other cities or other countries or go back to developing detached dwellings on the urban fringes of Melbourne where there are low costs, low standards and a massive supply of land.

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Bilby's picture

... there will be fewer sites available overall? Perhaps. But the scale of reduction relative to the number of suitable sites available and the rate of population growth are the important considerations.

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theboynoodle's picture

So yes, it's a competitive industry, and we compete on margin blah blah

I'm not sure what the shouting point is, there. I don't think anyone suggested otherwise.. and so what? If all developers are subject to a rule that elevators had to be gold-plated then that would increase costs for everyone.. and if they were capital constrained and forced to choose between projects then they'd all choose to allocate their capital to projects in cities that did not require gold-plated elevators.

There will be some more pressure on everyone's bottom line, sure, but only notionally. Developers will continue to cost projects individually and reconfigure those projects to maximise their profit. So the hypothetical 2020 tower will still arise, it will just look slightly different than what it would have before the regulations.
Meaning all of that bulldust about reduced supply side forcing up the overall price of developments is rubbish too. That's just one giant assumption turned into prophecy.

Not really. If that 2020 tower has 100 apartments in it, whereas the 2015 tower would have had 110, then that plot has yielded 10 fewer dwellings and unless there is more development elsewhere that's a reduction in supply. The link between supply and price isn't the direct and obvious link that some would have you believe, but it is a thing. However, this can be avoided if planners and developers can work together to make sure that the regulations don't mean fewer dwellings are delivered.. so it's an entirely avoidable consequence.

The actual factors in determining what a specific parcel of land sells for are SO weakly correlated to "supply" as a headline concept that they can and SHOULD be ignored here.

Can you explain what point you're making here? Are you talking about the supply of apartments or the supply of development plots?

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Ian Woodcock's picture

Whether or not someone can make whatever profit the banks want on a development is related to a range of factors: value of the location, proximity to good mass transit, planning scheme controls, etc. The last of these, when it comes to Victoria, are the most contestable and it is here that developers can make the ambit claims that have driven Melbourne's history of speculation as much as the outcomes that actually get built. It's well-known that if a developer wants to push the envelope, then they can by putting in a DA for something that is way over the height limits (say, 16 storeys in a 3-5 storey area) and come out of VCAT with say, 10 storeys - that's well-over twice the planning scheme height, so they're making a lot more than they would have bargained for when they bought the land with a residual land valuation based on the planning scheme. But, even though the approved scheme is less than 2/3 of what they applied for, it's still viable, or should be, because the price they paid should have been based on 3-5 storeys.

So, this kind of thing goes on all over town, all of the time, and people on-sell, without having to build, but making huge profits from just raising the height limits by obtaining permits by gaming the system.

What does this have to do with the discussion about apartment standards? Well, it's the same issue - developers will calculate the price they're prepared to pay on the basis of what they think they can get away with versus what the planning scheme says they can do. So, all it will do is change the dynamics of those equations a bit - and mainly in those parts of town where there is a market for teeny-weeny, dark, unventilated dwelling units without balconies. In the nice parts of town, where no-one would dream of trying to sell something like that, nothing will change, and the sky won't fall in. It didn't in Sydney after SEPP65 came in, and it hasn't anywhere else in the world where apartment design standards exist. After all, it is only an extension of the already existing set of regulations on what it is acceptable to sell as a habitable space. It is not as though this is something totally un-precedented, it's been under discussion for a long time, and prudent people would have factored that into their calculations when buying real estate.

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