Industrial and logistics 2021 – Looking back and looking forward
It has been another record-breaking year for the industrial and logistics property market. A lot of fun for those that work in the sector. For the first time prime industrial yields sunk below prime office yields on the back of record capital investment in the sector. Consumption rates for land take up have been as a strong as ever. Pricing for assets across all areas of the sector, from englobo development land through to land subdivision sales and tenanted asset sales, remains incredibly strong and shows no sign of abating yet.
We thought we would look back and share some of the key legal issues we have seen in the sector over the last year, and then look forward to what next year may bring.
With the availability of large sites for development dwindling due to supply constraints for suitable zoned and development ready land, the need to deal with multiple owners to piece together deals has increased and we have seen an increased use of options as an acquisition instrument.
On one view, options are not that complex. Agree an option period and an option fee, and you have your foot on the land whilst you try and lock away neighbouring parcels of land. However, two areas we have seen debate between landowner and purchaser are:
- Conditions to exercise an option. These are often around planning outcomes. It is critical that any conditions to option exercise are clearly drafted and, from a purchaser’s perspective, ideally provide the purchaser with some discretion to determine if the condition has been satisfied or not. We have seen eager landowners try to call early that a planning condition has been satisfied on a rezone or permit being issued. It pays to make sure that any planning condition has discretion for the purchaser to determine if the authority conditions attached to such a planning instrument are satisfactory.
- Striking the price – Unless the total price for the land is fixed in the option, the price for the land will be determined by an agreed methodology in the option.
For example, that may be through multiple prices per square metre for different land uses (often a split between, essentially, developable land and non-developable land). Making sure that, if using different rates per square metre for different classes of land, each class of land is described clearly and measured accurately is critical. It is also critical that you fully scenario test the calculations so that they work as intended and there is, ideally, little room for debate in striking the price when the time comes to exercise the option.
An alternative pricing methodology may be a market valuation upon a certain event occurring. This is perhaps the one pricing methodology where there is the most room for dispute, as one valuer often has a different view to another. The option should clearly set out how the valuer is appointed (ideally the purchaser can steer this appointment), and what the valuer should have regard to in valuing the land.
Key message: In a rising market, and lots of press around record sales that landowners will be choking on over their cornflakes each day, make sure your pricing methodology is as clear as possible, scenario tested and leaves little or no room for dispute.
Sub-sales and double duty and land development
Nominations of contracts or assignment of options typically occur either for corporate structuring purposes, or if the option or contract is being traded. In the current hot market, we have seen a rise in the number of options and contracts being traded.
However, it is important to be aware that when nominating under a contract of sale or assigning the benefit of an option the instances when double duty may be triggered (on nomination and then again on settlement) have been expanded by the State Revenue Office.
As a reminder, double duty will be triggered if:
- additional consideration is paid for the nomination or assignment (i.e. anything more than a reimbursement of the contract price or option fee); or
- land development has occurred before the nomination or assignment.
It is in the land development space that the State Revenue Office (SRO) has now entrenched an expansive interpretation of the applicable legislation. New rules on what constitutes land development came out in September 2021. The SRO has now confirmed that engaging surveyors or other consultants to undertake development work, preparing a draft plan of subdivision and preparing a planning application are all included in the definition of land development.
Key message: Double duty may not be an issue if additional consideration is being paid for the right to nominate a contract or assign the benefit of an option – in a rising market the parties may view the additional hit of duty simply as a transaction cost. However, if the nomination or assignment does not involve additional consideration, do not undertake any development activities before you nominate or assign the benefit of an option. See also our more detailed article on the changes from September this year.
More State taxes
Surprise! Another State government budget, more property taxes. There were increases to stamp duty and land tax, and the introduction of a new tax, the Windfall Gains Tax (WGT), just to keep things interesting. See the table below for a short summary:
The big ticket item is the introduction of the WGT which applies to land that is subject to a rezoning that results in a value uplift of more than $100,000. The taxable uplift is the difference between the capital improved value of the land before and after rezoning takes effect, less any deductions. The valuer general will be responsible for land valuations. Landowners are legally liable to pay the tax, but there are some situations where it can be deferred. Note that the tax does not apply if the land is with the Growth Area Infrastructure Contribution (GAIC) regime.
Key message: The devil really is in the detail with this tax, particularly around transition arrangements for contracts and options exchanged before the tax was first announced. We have prepared a number of articles on the tax – see here in particular for a summary.
For those projects where land is sold and capital recycled, the Supreme Court case of Burger and Ors v Longboat Holdings Group 2 Pty Ltd  VSC is a reminder that if you make changes to your development scheme, those changes may consititute a material change under the Sale of Land Act 1962 (Vic) (SOLA) and give rise to a purchaser right to withdraw from the contract in off-the-plan sales.
The Burger case dealt with changes to a residential apartment, but the principles apply to any subdivision. That case held that if there is a change in area of a lot on a plan of subdivision that is less than 5%, then such a change may constitute a material change under section 9AC of the SOLA, depending on the circumstances. It is worth noting for 2 principle reasons:
- until the Burger case some in the market held the view that any change in area of a lot on a plan of subdivision of less than 5% could not be a material change under section 9AC of the SOLA
- in many industrial land sales, the fact that there may be a price adjustment mechanism for changes in area of less than (or even more than) 5%, does not preclude the operation of section 9AC of the SOLA.
It would probably lead to an argument by a developer that the parties clearly contemplated changes on the plan of subdivision when the contract was signed, and therefore that any change in area was not a material change for the purposes of section 9AC of the SOLA. However, the circumstances of the actual change in area (does it limit access or cross overs for example) will still be relevant, and it could be that with such changes a purchaser has the option to elect for either a price reduction or to withdraw from the contract.
Key message: In a hot market with rising prices, it is probably unlikely that a purchaser would want to withdraw, but if the market for land ever does top out and turn, that is when purchasers can look for reasons to exit. For more details on the case, and a reminder of some of the key cases and principles around section 9AC of the SOLA, see our October 2021 summary.
There were many other trends that we saw in 2021, including the extent and complexity of leasing incentives continuing to grow aggressively, but the above are some of the key highlights.
What about 2022?
It seems that the current and pending land supply shortage, and lack of tenanted assets when compared to the passive capital looking to invest in the sector, will see land and tenanted asset prices continue to grow. From a legal perspective, we consider the following will be some of the key issues to be across:
- trying to get your foot on land to develop will require the need to be creative, both commercially and legally, with acquisition models – options, conditional contracts, fund through and beyond. Watch out for that double duty
- being able to manage and mitigate your property taxes and holding costs will become more important than ever
- understanding fully the windfall gains tax for rezoning plays will be critical
- significant rent escalation surely has to start to follow the land price rises soon, and the incentive package for tenants will be an increasingly competitive space (even from their current healthy levels!), along with no doubt some interesting market rent reviews. Make sure you have a good panel of valuers at the ready
- price escalation and material shortages in the construction sector. Whilst the world is slowly recovering from the pandemic, the not unrealistic possibility of more short snap lockdowns and disruptions to the global supply chain will result in the development of assets requiring robust construction documents and flexible terms with any land purchasers or pre-leasing commitments to tenants.
Whatever 2022 brings, it looks like another year of opportunity for those involved in the industrial and logistics sector. Feel free to reach out to the Development team at Maddocks to help with any legal issues on your projects.
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