The Regulator: friend or foe of Sydney property buyers?

July 10th, 2019

Most property buyers in Sydney come to the table with similar preoccupations and questions: does the house or apartment they are looking at have a view? Is it north facing? Are there any noisy bars in earshot? How far is it from a train station? How far from a good school? Is there a beach or park nearby?

Yet a far less appreciated factor to consider is regulation: both over-regulation (for example, the Sydney lockout laws which had dealt a death-knell for entertainment in Kings Cross) and chronic under-regulation (demonstrated by the crisis currently engulfing the construction industry).

Macro-level regulatory risks affect all properties: principal movers and shakers include the Reserve Bank of Australia (RBA), Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) who, together, regulate interest rates and lending standards and thus, the availability of credit. The occasional Royal Commission can also have a major effect on how regulations are applied.

This CurtiseCall, however, will address regulatory risks of the micro variety, focusing on the construction industry.

 

Regulatory risks: Why they matter

Regulatory risks matter more than ever today, given that Australia might soon tip into a recession after 27 years of uninterrupted growth. Annual GDP growth has now fallen to 1.8 percent, with three consecutive quarters of negative growth. Real wage growth, too, has stayed sluggish for the last six years.

Since April’s CurtiseCall, which addressed Australia’s rampant and damaging “media mania” regarding property news, there have been two interest rate reductions totalling 0.5 percent, taking the official cash rate to a historic low of one percent.

Finding out where risk lies when purchasing a property – and future proofing that investment — has never been more important.

 

So who is in charge?

Three regulatory tiers of government can affect property buyers either positively or negatively: the Commonwealth, state and local government.

 

The Commonwealth

Historically and for constitutional reasons, the Commonwealth government has been the least intrusive of the three at the micro level, leaving the other two to bear the burden.

The Commonwealth’s influence is mainly felt at the macro level via the taxation regime and can have a major impact as demonstrated, for example, by the uncertainty Labor’s proposed reduction of negative gearing and the capital gains discount generated. Other areas where the Commonwealth reluctantly dips its toes into the property water is by partial funding of infrastructure projects otherwise administered by the different states.

The Commonwealth also regulates aircraft movements whose flight paths for some can change once quiet suburbs into hellholes of intolerable noise for many buyers.

Finally, there is climate change: inaction from the conservative and climate-sceptic Scott Morrison government will result in rising sea levels threatening many Sydney properties with inundation and others with increased risk of destruction by bushfire.

 

State government

Historically and even more so now, the New South Wales state government is the tier most likely to have a direct, sledgehammer effect on properties. Its tentacles reach everywhere (and in some cases not far enough), which in itself adds to the risks and costs buyers face. Topics to watch out for that can affect a Sydney property investment include:

–       Stamp duty
–       Land tax
–       Planning laws
–       Regulation of the construction industry
–       Regulation of short-term stays in buildings such as AirBnB
–       Sydney’s lockout laws
–       Regulations over heritage listed buildings
–       Infrastructure projects
–       Low cost accommodation including boarding houses and public housing
–       Contaminated land, water and air
–       Road and rail infrastructure.

 

Local councils

As to the third tier, whilst local councils have gradually and reluctantly ceded many former responsibilities and powers to the state (the starkest and most controversial case being the state enforced council amalgamations), their actions and inactions should not be ignored by buyers.

Local councils still administer many Development Applications, can close off streets, change garbage collection days, on street parking and regulate tree felling. They can even close a business down forcing the owner to re-purpose the real estate. Put simply, local councils might seem like small fish in a big pond but they can still make or break a property, whether that property is a home or investment.

 

The construction industry: too high, too fast

Of all the issues listed so far it is the construction of shoddily made high-rise blocks over the last twenty years that should alarm buyers the most. (These potentially include apparently higher quality developments, as well as budget developments).

On June 14 this year, residents from 131 apartments in Mascot Towers, located in Sydney’s inner-south, were evacuated. A giant crack had opened up in the decade-old ten-story building. Today, just under a month later, the high-rise remains empty.

Mascot Towers, alarmingly, is not a lone case. Last Christmas Eve, Opal Tower in Sydney Olympic Park was also evacuated following a series of loud cracking noises. Structural issues were discovered and by April 169 of the tower’s 392 units – or almost half — were still vacant, according to the ABC.

Residents of both buildings have had little choice but to pay for hotels, kip with friends, or rent other accommodation, with no compensation in sight.

 

Big mistakes. So who pays?

It is estimated that 72 percent of all strata schemes in New South Wales have defects, according to City Futures Research Centre at the University of New South Wales (UNSW). And when issues arise it is, by and large, the owners of the apartment blocks who are left with the bill – in the case of Mascot Towers, a bill that could run into the millions.

Mascot Towers and Opal Tower have made front-page headlines. But many as pressing defects – from lead discovered in the tap water to issues around waterproofing and faulty fire exits – are underreported in the press.

According to research conducted by the City Futures Research Centre, the most common defects found in apartments were internal water leaks, cracking to internal and external structures and water penetration from outside.

Yet a lack of reporting leads to a lack of transparency and a potential nightmare scenario for future buyers, who might see their golden investment rapidly turn to dust.

When defects are found, the value of the property can dive; rental yields plummet; or, in the worst-case scenario, apartments can become virtually unsaleable.

Getting redress, meanwhile, is often punishing. First, the statutory warranty period for claims for recompense only lasts up to six years for major defects and two years for minor defects. Second, as in the case of Mascot Towers, builders/developers might go into administration.

And while there now exists a new recompense scheme – with developers forced to put two percent of the cost of development into a bond – the money collected is hardly enough to scratch the surface of major structural damage.

Wherever the fault in the building lies, “the end result is the same,” as Geoff Hanmer, adjunct lecturer in architecture at UNSW, put it in The Conversation. “Misery for the residents and a looming financial disaster for the owners.”

 

The craze for high-rises

Sydney is shifting from a low-density largely suburban city to a high-density city, increasingly made up of high-rise apartment blocks. Looking into the future, with Australia’s population set to hit 30 million by 2029, Sydney will unfortunately see yet more massive urban renewal projects and high-density developments such as the bland and unprepossessing Green Square.

Reflecting this, today more than 30 percent of the Sydney population live in apartments. Over the last half-decade, over 100,000 apartments have been built, with another 140,000 predicted for the next half-decade.

Pushing for more high-rises is not just a population hungry for an inner-city lifestyle and/or low-cost living and affordable housing, but the federal government itself. Construction works generate GDP (much needed as Australia faces a potential recession), while big developments provide state taxes and increased sales stamp duty.

 

More high-rises, sure. But why the construction industry crisis?

In the 1990s, the Building Code of Australia, later renamed the National Construction Code, was introduced with the aim of reducing regulations around development. The Building Code set out to reduce the often-high cost of construction by cutting down on pervasive regulations. Out went the red tape; up went the high-rises.

Another issue, as The Sydney Morning Herald reports, are the “design-and-construct” contracts for residential high-rises.

“The design-and-construct model means a developer can get approval to start a project on the basis of partial concept drawings, a builder then tenders for construction and takes over the rest of the design work as construction takes place,” writes The Sydney Morning Herald in a piece published last month subtitled, tellingly, “Why the Opal and Mascot Towers cases may be the tip of a very large iceberg.”

Design-and-construct, adds The Sydney Morning Herald, “is a bit like pass the parcel”. Whereas once one architect or engineer would overlook the entire project, now different engineers and architects take up the baton at different stages leading to errors and, critically, a system that enables individuals to evade responsibility if something goes wrong.

 

Too much, too soon

However, in the craze for new apartment blocks – and in the frenzy to generate income, whilst simultaneously constructing on the cheap – cracks, literally as in the case of Mascot Towers, have begun to appear.

The true cost of such cheaply made, quick-to-construct developments is only becoming apparent to buyers now.

“As locations such as Sydney rely more and more on the construction of high-density housing to accommodate their growing populations, it is essential that the community has confidence in the performance and reliability of the building industry,” says Carol Mills, director of the Institute of Public Policy and Governance (IPPG) at the University of Technology Sydney (UTS).

“The impact of issues such as those that have arisen at the Opal Tower and Mascot goes far beyond the immediately affected residents,” she says. “They raise concerns across the wider community about the performance of the building industry which is damaging to the housing market in general.”

As such, insists Ms Mills, it is “important that there is a focus on prevention in the residential building industry, particularly through a renewed emphasis on quality and safety standards and effective compliance systems. Such actions are vital steps to improving community confidence. This requires action from builders, industry bodies and government, including through more effective regulation.”

Or as Dr Laurence Troy, a research fellow and lecturer at the City Futures Research Centre at UNSW, puts it: “The biggest red herring in the apartment space at the moment is the lack of regulation in the building space. You have to be very cautious about buying new apartments these days because you just don’t know what the quality of the building is like and what issues are hidden. So there’s potential huge risk involved in buying apartments that have been built in the last 20 years.”

 

A softening property market brings concerns into the spotlight

“Concerns about building defects are not new. There have also been plenty of other calls for reforms long before the Opal Tower evacuation,” notes Professor Hazel Easthope, an associate professor and UNSW Scientia Fellow at the City Futures Research Centre.

Yet Professor Easthope believes that the issue is getting traction now largely because of the softening property market.

“When property prices are going up, the cost that owners bear in fixing defects can be offset against their capital gains,” she explains. “Sometimes owners chose to repair defects rather than making the issue public through legal proceedings, both because it may be cheaper in the long run, but also to protect the reputation of their buildings and hence their property prices. However, when property prices are soft, there isn’t that cushion and the costs of rectification can be too much for the owners to bear.”

Ultimately, owners of apartments in faulty buildings often want to keep problems hushed, so that the prices of their investments don’t plummet; others who do manage to successfully sue construction companies often then have to sign non-disclosure agreements meaning the company never has to answer to the public.

Either way, transparency is sacrificed and consumers, in the end, lose.

 

Re-instating basic consumer protections

Professor Easthope insists that “we need to re-instate basic consumer protections for purchasers of apartments.” This can be done, she says, through the re-introduction of mandatory last resort insurance (i.e. insurance that pays out when the builder is no longer operating) for all owners; clarification that certain classes of building practitioners will have direct liability to subsequent purchasers of strata units if there are defects; and the extension of the two-year period of statutory warranties for minor defects to a more reasonable timeframe (e.g. six or seven years).

That said, New South Wales state governments “have not only not acted on building defects, but have actually reduced the safeguards in place to protect strata owners,” says Professor Easthope. “This has included a reduction of the period for claiming on statutory warranties from seven years for all defects to six years for ‘major’ defects and two years for all other defects, as well as the removal of the requirement for home owners warranty insurance for buildings of four or more storeys.”

 

Prevention, not cure

Yet Professor Easthope recognises that one of the problems with “holding everybody to account” is that “it can be difficult to pinpoint precisely who is to blame for particular sub-standard work… This just makes those legal cases more drawn out and expensive.”

“Another problem,” she adds, “is that when these things do finally get to the point where there is almost a court case, the builder or developer being sued makes an offer (usually less than the actual cost of the works) on the condition of a confidentiality agreement.”

As such, it is imperative to change not just rules and regulations but the culture of the construction industry itself.

“Law in the books and law in action are different things. Regulatory failure is likely to occur if policymakers and regulators do not carefully think through how rules will be implemented and if they can reasonably be enforced,” notes Jeroen van der Heijden, professor of public governance at the Victoria University of Wellington.

“We don’t want to have a building inspector on a building site 24/7 and checking each and every nail that goes into a building. That would make the process of monitoring and enforcement too costly and stifling for both the regulator and the builder. Key is to develop regulations that are understandable, can be monitored within the limitations of what a building inspector can reasonably do on a building site, and come with meaningful enforcement measures,” he says.

What’s more, Professor van der Heijden believes that while crackdowns are “good to signal government is taking building safety seriously, they are not good to change the culture in the industry in the long run. They are also not helpful to increase bottom-line performance. Crackdowns are, at the end of the day, reactive. A good regulator makes sure to be pro-active and prevent problems before they happen.”

Bronwyn Weir, managing director of Weir Legal and Consulting and co-author of the 2018 report “Building Confidence: Improving the effectiveness of compliance and enforcement systems for the building and construction industry across Australia” tells buyers’ agent Curtis Associates that there is no “silver bullet” to fix such issues.

In the report, commissioned by the BMF (the group of ministers responsible for building and construction), Ms Weir and her co-author Peter Shergold make 24 recommendations, ranging from better education and training of tradespeople to more thorough inspection regimes and auditing practice.

As it stands today, they write, “those involved in high-rise construction have been left largely to their own devices.”

 

Private certification

A risk also arises when regulators cease to regulate and instead, privatise matters that should be regulated: one example is such privatising land titles, which saw property search fees rise dramatically. Another is private certifiers.

“There is a massive debate raging now about whether private certification is corrupt,” says UNSW’s Dr Troy.

“Someone will need to keep an eye on the private certifiers,” agrees Professor van der Heijden. “If the regulator only has knowledge of the administrative process of private certification but not the content, it will not be able to assess the quality of work provided by private certifiers. That gets the regulatory regime on a slippery slope where private certifiers realise they can get away with some things, then with other things, and ultimately with so much that the regime collapses.”

Or, as Ms. Weir explains to Curtis Associates, there is an “inherent conflict of interest that arises when a person exercising a statutory function (to issue approvals across states) or certify documents so that local government can issue approvals is engaged by an owner/developer or builder. The perception is that their independence will be compromised by conflicting commercial interests held by their ‘client’. As noted, this potential conflict is inherent in the model.”

 

What about flammable cladding?

When Grenfell Tower in London burned down in June 2017, the issue of flammable cladding on buildings was catapulted, tragically, into the world spotlight.

In Australia, as in the UK, flammable cladding is an issue that needs to be fixed fast to prevent lives being lost – through not just more but better regulation. Just under 450 “high-risk” buildings with combustible cladding exist in New South Wales and 900 in Victoria, according to The New Daily.

As such, the Commonwealth should eliminate cross border inconsistencies in state laws to help raise national safety standards.

“In the last few years we have learned a great deal about the state of our buildings – particularly high rise high occupancy residential properties and what we’ve learned isn’t pretty,” notes British engineer Dame Judith Hackitt in an article published in Architecture & Design after her recent visit to Australia.

She adds that the competency of the workforce is often in question; sanctions are too weak on those who break the rules; and record-keeping is poor. Ultimately, she writes, “we need to drive a massive culture change in the whole construction and built environment sectors that holds people accountable for designing, building, maintaining and managing buildings which are safe for people to live in.”

 

Too much regulation, a bad thing?

For all this, too much regulation can be a bad thing for some property buyers – with the lockout laws in Sydney a classic example, earning Australia the reputation of a nanny state, while killing the nightlife in the once buzzing precinct of Kings Cross and moving party revellers to other areas such as Newtown and Double Bay. While great news for homeowners in parts of Darlinghurst and Potts Point, such a shift in the landscape is bad for owners of commercial properties forming what is now a boulevard of long term vacant shops fronts.

“A right balance in government regulation is the key, requiring urban management skills and design governance capacity,” says Professor Richard Hu from the faculty of Business, Government and Law at Canberra Business School.

But, as Dame Hackitt points out in her article, “complex prescriptive regulations and guidance are not helpful – they lead to confusion, accidental and deliberate misinterpretation of what is written down.”

Eoghan Lewis of Sydney-based Eoghan Lewis Architecture also believes that too much regulation means that the “‘good’ (surprising, generous, innovative, exciting, paradigm-bending, risk-taking, more sustainable etc) projects becomes much more difficult and innovation is reduced to the building’s clothing because a set of design rules in the name of amenity lead to a specific and narrow set of design outcomes.”

“Wandering around Sydney’s brave new world of Green Square is sobering,” he adds. “There is a kind of visual tedium or blandness where everything is kind of ‘okay’ but nothing is great and choice is not really choice at all as everything is a variation on a theme. It is the collective impact of building after building doing more or less the same thing that is depressing. It’s boring.”

What’s more, Mr Lewis believes that for property buyers this is reflected in issues around buying off-plan.

“When apartments are sold off the plan the marketer is king and built quality as well as design quality suffers; where is the incentive to build things well when the building has already been sold?” he asks. “This also happens in the commercial space where a developer may off-load their development before or during construction so again, the incentive to do things well evaporates. Some Council’s are keenly aware of this problem like the City of Sydney but there is only so much they can do.”

However, “the market seems happy enough with this situation and everyone knows that a well-designed building doesn’t necessarily mean a better return for the developer. It’s a cultural issue more broadly – we’re happy with what we get (the market is not very demanding). What sold yesterday will sell tomorrow. The paradigm rumbles on.”

 

Buying property safely

Professor Easthope, for one, recognises the risk involved in purchasing property: and that “currently it’s not possible for potential purchasers to find out about building defects with certainty before purchasing (especially if they’re buying a unit that hasn’t been built yet off the plan).”

What’s more, losing trust might well have an effect on the property market moving forward. As Professor Bill Randolph, director of the City Futures Research Centre, has told The Sydney Morning Herald: “If people don’t trust what they are buying, they won’t buy it, lenders won’t lend, developers won’t be able to sell off plan, planners will be frustrated … governments won’t be able to house thousands of people heading towards Sydney and Melbourne, and the system will break down.”

For now at least, unless and until there are significant reforms, it is more essential than ever for Sydney property buyers to focus on regulatory risk when doing their due diligence.