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What Australia’s cladding crisis means for commercial property investors

Categories: Commercial, Investments

Cladding mightn’t be the most exciting topic to discuss at the water cooler. But for commercial property investors it’s a matter that deserves plenty of attention. Here we explain Australia’s cladding crisis and what investors can learn from it.

The country’s largest courtroom battle this year is almost underway. Hundreds of individuals and companies caught in Australia’s cladding crisis, which has seen authorities deem over 3,400 residential apartment buildings unsafe because of non-compliant or combustible cladding, are believed to be involved in a class action where compensation could hit the billion-dollar mark.

But many may be asking, “What is this cladding crisis?”

For those in the business of investing in or developing large real estate assets (such as apartment buildings or commercial property), it’s an important topic that has reappeared in newspaper headlines for the fact that cladding – described as the outside skin of a building, which protects a particular surface, like roofing or walls – in many apartment buildings around Australia have been declared non-compliant and/or combustible. It has shaken up the country’s building and development industry and provided many learnings for those stakeholders of commercial real estate.

Victoria’s ban on external cladding products

Sadly, the replacement program for flammable cladding has forced many business owners and developers to declare bankruptcy, or at least fork out an incredible amount of money, to rectify the non-compliant cladding on their properties. Plain and simple, it is a multi-billion-dollar issue.

Costs on an individual basis have been quoted in the realm of $30,000 to $12 million, of which some homeowners have even been forced to pay themselves.

In Victoria, over 70 buildings have been classified as “extreme risk” and another 368 as “high risk”.

It has forced the state government to amend its building code, declaring that aluminium composite materials (a sandwich of one polyethylene [plastic] core between two pre-painted aluminium sheets) with a core of less than 93 per cent inert content used in external insulation will be banned.

Currently, the cladding crisis is focused primarily on apartment buildings. But as we’ll show, investors of any sort of commercial asset should heed the loud warning.

NSW and the cladding taskforce

The NSW Cladding Taskforce, established to identify buildings with potentially combustible cladding (the Taskforce has audited over 185,000 building records and performed 4,000-plus inspections), says that over 400 buildings in NSW are due to have cladding removed.

Buildings are only considered cleared if:

  • they do not have cladding that FRNSW considers a safety risk
  • the cladding has been investigated and cleared by a consent authority
  • unsafe cladding has been fully remediated.

In NSW, 225 buildings have been deemed “high risk”.

australia cladding crisis

You can quickly see the financial damage caused to owners and occupiers of these buildings, with the incredible cost to repair non-compliant cladding multiplied by the sheer number of buildings flagged for combustible cladding removable.

Apartment building owners – the biggest victims in the NSW cladding crisis – have been given an additional two years (on the existing 10-year timeframe) to launch claims against the builders responsible.

Combustible cladding not tax deductible

To add further pain to certain owners of flagged properties, the ATO ruled in August 2018 that combustible cladding – if found on an income-producing property – will not be tax deductible.

While many compared combustible cladding to the asbestos problem, victims of the latter were able to claim the costs of asbestos removal and replacement come tax-time. Combustible cladding victims have not been so lucky.

What is the message here?

The crucial learnings for property investors is simple: Perform a thorough due diligence on your property investment.

For a landlord to succeed in commercial real estate investment, every box must be ticked, every shadow shed light on, every nut and bolt in the property’s interior and exterior checked, re-checked, and checked again. There are no shortcuts when it comes to performing a due diligence of your commercial property investment, and this is where many investors get it wrong – especially when being so close to their unconditional date.

We’ve said goodbye to tens of thousands of dollars (our own expense – not our investors’) when determining an asset didn’t meet our strict criteria.

And we’re okay with that. We’re always okay with that, because it shows our dedication to presenting our investor base (of which we are a part of: we invest alongside our investors in every investment) with a commercial property investment of the highest quality. Investors come to us to shed their concerns, rid themselves of worry, and ditch the risk of investing in commercial property by themselves. So, we ensure their commitment to us is returned ten-fold in our dedication to serving them the most safe and secure investment possible.

And it all starts with due diligence.

While the documented components of a commercial property investment can seem tedious and full of fine print, it can really be the physical due diligence – checking the building itself, the bones of the property – that requires the microscope.

Sure, reviewing a full building condition report is critical. But how about understanding that report, from head to toe? Knowing what to look for, what to ask the engineer post-building inspection, can be the difference between a care-free investment and a $30,000 to $12-million cladding bill during the ownership of a property.

And beyond this, investors need to realise the consequences of leaving stones unturned. How many victims of combustible cladding in Australia would know that the material plaguing their building is not even tax deductible?

And don’t forget the Reserve Fund. While there’s no one-size-fits-all approach to building a reserve fund for each and every property investment, the importance of having cash in reserve, in case an unexpected incident like this occurs, is beyond question.

Does commercial property investment seem too complex? Too exhausting? It doesn’t have to be. Consider reaping the rewards of high-yielding commercial real estate investment by investing alongside a commercial property syndicator. 

At Properties & Pathways, we offer exclusive unlisted direct property investment in high quality commercial assets. And the best part is we invest with our investors in every investment. This bolsters our commitment to each investor, as we’re in it with them, bumps and all. 

For more information on how to invest with us, choose one of the options below:

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