The development land market is being primed for significant growth
The market for development land is in an interesting phase. By traditional measures, with a growing economy and population, rising house prices and commercial rents and very low interest rates, the sector should be red hot. Yet, Cushman & Wakefield report that, for Q1 this year, whilst the number of sales was up by 67pc, the total value of deals was down by 41pc compared with last year. Does this indicate falling values, or is it a statistical blip? I suspect it is the latter and I believe that the value of land is poised for strong growth over the next three years.
The fundamental factor deciding the value of land is the profitability of developing on it. And therein lie the reasons that have been preventing land values from matching the rising economy.
Chief among these is the cost of finance. Whilst the cost of funds has never been lower, property development is still regarded as 'high risk'. Banks, scarred by writedowns on land values of up to 80pc following the collapse, remain overly nervous about funding development. Developers are telling me that the pillar banks are still not funding development, other than on small sites with existing planning permission.
This has left the door open for equity funds to finance developers at rates from 8pc to 16pc, and earn supernormal profits. This cost to the developer comes straight off the value of land. Buying well-located land has always been a good long-term bet (as they say, they're not making any more of it) but developing is different to other sectors of the market in that there is no income from land - until it has been developed. That accentuates the sensitivity of development to financing costs, and delays in getting planning quickly affect profitability.
Another big factor is the cost of construction. Developers who had sites ready to go were waiting for house prices to increase enough to make development viable. Sure enough, house prices have been increasing, at up to 10pc per annum, but the problem is that construction costs have increased by the same rate - and even more in Dublin. Again, we are coming out of a period where the construction sector was decimated, manpower dissipated and machinery sold off. The main contractors are almost too busy now to tender for work and the lack of capacity is causing prices to rise fast.
This is affecting the value of apartment sites most of all, as apartment blocks are more complicated to build than houses. Commercially, activity is very strong for offices and hotels, driven by rising rents and room revenue, but nervousness about the impact of internet shopping is holding back development in the retail area.
All of this makes it difficult to value land at the moment but indications are that developers are back to paying approximately 20pc of the final value of a property, for the site element, which has always been a sensible guideline.
Cushman & Wakefield do identify a strong supply of sites coming on to the market and we should see a good increase in the number of deals - boosted by the release of State lands and continued dripping of sites into the market by Nama.
Developers perceive better value, but more risk, in the regions - Cork, Galway and Naas, Co. Kildare, are in vogue, but activity in many provincial locations is limited. The proposed fast-track planning process for applications over 100 units has been well received and An Bord Pleanala are understood to be hiring 10 senior planners to handle demand.
The mood of developers is cautious but optimistic, and they are keen to see more sites coming on the market. The simple solution to the lack of supply is to halve VAT rates for five years to generate competition.There is an element of 'flipping' of land going on by early purchasers, but developers are not rushing to buy sites in secondary locations at the prices suggested.
Sales of new homes are strong and Sherry FitzGerald report a 100pc increase in closed deals for Q1 over last year. It's not hard to foresee that the profitability of schemes will continue to improve, and as evidence of success mounts up, the banks will decide at the same time to re-enter the market, financing rates will tumble, and land values will increase.