A tale of two cities

by Kathryn Crossley01 Jul 2015
Over the past 12 months good economic conditions, low interest rates, high demand and limited supply of residential and commercial properties, a new wave of PPP projects and an influx of foreign investment have converged to create ideal conditions for New Zealand’s property and construction sector. Lawyers working in this area have enjoyed an extremely robust year, but it seems that the activity has really only just begun. New Zealand is poised to experience a $100bn construction boom over the next three years, and property and construction practitioners are reporting healthy and growing levels of activity across most parts of the market.

Wellington has remained steady, and some of the city’s lawyers have been busy working on the PPP pipeline, but Auckland and Christchurch are the centres that are really grabbing headlines.

Christchurch: The rebuild continues

The scale of the Christchurch rebuild means that construction work will be a feature of the city for many years to come. A number of anchor projects are yet to be finalised, and some housing is still to become available.

The process of rebuilding the city has itself created even greater demand for new residential properties. “What we’re starting to see happen is people who have gone there for the work decide to stay down there, so that puts increased pressure on the housing,” Anthony Harper partner Edward Dunphy says.

In relation to commercial space, Dunphy has observed a growing trend of building on spec, with offices going up with only one anchor tenant secured. He expects that the additional space in these buildings will soon start to be filled. “If you’ve got a three-storey or four-storey office building, you need a commitment to at least 50% of that, but a lot of firms can’t commit to taking that kind of space … they need to wait until things are developed,” he says.

Practitioners do not expect that reforms to health and safety legislation will mean significant changes for construction clients, as construction companies already have very strict worksite safety rules. “I’ve always observed that our clients have been careful to manage their health and safety obligations properly, and so the nature of the legislation, as I understand it, is unlikely to give rise to a change in what’s being done to manage health and safety, but it obviously increases the importance of getting it right,” says Russell McVeagh partner Ed Crook. “I think most prudent developers and contractors would be doing what they’re required to do anyway.”

However, the Canterbury earthquakes have brought about a new perspective on those laws. The seismic strength of buildings and the implications of the Health and Safety in Employment Act 1992 for owners and occupiers has been thrown into sharp relief, says Thompson Blackie Biddles director Joe Biddles.

“Since the Christchurch earthquakes, we have seen a significant focus placed on this area, and this continues to be a focus for investors/occupiers,” Biddles says. “This issue has added another element to transactions, making it a factor to be considered/addressed in many investment decisions.”
 
Auckland: Cranes on the skyline

The continued migration of corporate head offices to Auckland has drawn attention to the city’s tight commercial rental market. “There’s only something like one or two per cent of available space in the premium and A-grade office buildings, and I think it’s impossible in the Auckland CBD to get two floors one on top of the other,” Dunphy says. As a result, a number of large office or mixed office and residential developments are in the planning stages or already underway.

When these projects are completed and their anchor tenants move in, this will free up space behind them and is expected to lead to considerable movement of office tenants around the Auckland CBD. “Because the stock is quite old in Auckland at the moment, we’re going to see some new buildings come to market, and it’s going to see a whole shifting and turnover of a whole number of major tenants moving between buildings,” predicts Greenwood Roche Chisnall partner Barry Walker.

At the same time, strong demand for commercial space in Auckland is also driving refurbishment activities in existing office towers. “Landlords now consider it worthwhile to upgrade premises in order to get the benefit of the uplift in rentals,” Bell Gully partner Tom Bennett says.

New Zealand’s positive economic outlook, coupled with the prospect of strong returns from Auckland’s commercial property sector, has also served to attract high levels of foreign investment, particularly from the Asian market, as well as Canadian and German pension funds. To date, those foreign investors have predominantly been interested in adding core CBD assets to their property portfolios.

“While the focus is not solely limited to Auckland, it does appear to remain the centre of choice for many overseas investors,” Biddles says.

Walker observes: “The stock in New Zealand is a bit older than you’ll find elsewhere. In particular, I remember from my time in Sydney, there is a stock of premium-grade buildings – there just really isn’t that here, so most of them are A-grade buildings but with great tenants, and the vacancy rate here is ridiculously low at the moment as well, so they’re very comfortable paying top dollar for those.”

Infrastructure work is also proving to be a strong driver of activity for the sector. In Auckland, work on the $2.5bn City Rail Link development is scheduled to begin later this year, and roading projects around Auckland and the Hamilton region are also taking place.

Residential demand skyrockets

Lawyers point out that high migration rates have exacerbated Auckland’s already-tight residential market.

“There’s been a bit of people from Christchurch taking insurance money and coming up to Auckland,” Dunphy says. “In Auckland a lot of work has been driven by net migration, so there’s a lot of people either immigrating to New Zealand or just moving back – there’s a lot of Kiwis moving back, particularly from Australia. The economy over here is a bit more stable, there’s more jobs around, so we are starting to see quite a lot of them coming back, and obviously as there’s people looking for jobs, there’s people looking for houses.”

Demand in Auckland’s housing market has brought on a flurry of residential development and subdivision activity. Despite the prosperous times for Auckland’s residential sector, industry players will be keeping a close eye on the Reserve Bank’s proposed lending restrictions, which are intended to take the heat out of the active market. In its current form, the proposal would require investors who are borrowing to acquire an existing residential property to have at least a 30% deposit.

The Unitary Plan

The new Auckland Unitary Plan is expected to have some impact on development, but most practitioners we spoke to were doubtful that it would be extensive.

“To the extent that people are able to get the zoning that they wish to have to allow for future development as a consequence of the Unitary Plan process, that will likely make it easier and might remove some barriers that may otherwise have existed in terms of being able to get the necessary consents … it will open up some land that might not have otherwise been available for development, but I think the sector overall will continue to be capital- and confidence-driven,” Crook says.

However, in Dunphy’s view, the unitary planning process may be prompting landowners to put lots of land on the market, and more vacant land has gone on sale over the last six to eight months. “People are finding that land is becoming zoned in quite an attractive way, so rather than trying to do any work or subdivision or development, they’ve started selling the bare land,” he says.

Regulatory changes

Lawyers noted that a few regulatory changes on the horizon might impact on clients, but they do not expect that new rules will have any significant impact on the market. Amendments to the Construction Contracts Act will change how retentions are managed and paid out. The Act is also being widened to cover consultants, but practitioners do not anticipate any major implications to arise from the change.

“It will be interesting to see what happens with design, engineering and quantity surveying services, which are now going to be brought into the construction contracts adjudication regime,” Bennett says.

Meanwhile, minor changes to the Building Act are expected to clarify some of the obligations and the operation of the Building Code.

Resource Management Act amendments may also help encourage activity. “The current government’s proposal to amend the Act to continue to unlock land supply and encourage development should have an impact,” Biddles predicts.

Coming challenges

Although insolvency events have been increasingly rare, the sector is not without its challenges. Lawyers were unanimous in their assessment that the biggest obstacle facing the sector in the year ahead was that of supply and the flow-on impact it would have on building costs. Shortages of land and human capital were top of mind. “There’s not a lot of land out there, so the prices people have got to pay to obtain land are getting higher, and the construction industry is starting to get stretched, both in terms of physical resources and people, so construction costs are going up,” observes Dunphy.

Interest from overseas players may also see an increase in market competition. “One of the things I’m really interested to see is how the instability in Australia, in particular in Victoria and Queensland, is going to shake through in New Zealand. There could potentially be a number of Australian contractors or even overseas contractors … who are now looking for a new market to put their people in whilst that instability and sovereign risk beds down again,” says Walker. “Potentially, and it’s quite strongly rumoured, there may be new entrants into the market over here, and also I think we’re going to see a number of players in the New Zealand market teaming up in one way, shape or form with overseas entities as well to try and get ahead of the competition,” he predicts.

Despite some of the challenges, the future for the sector is a largely positive one. “Ultimately there is an unsatisfied demand for good product in New Zealand, and as long as this remains it should continue to underpin the activity we have seen to date,” Biddles says.