In residential property, the law of unintended consequences is hurting a significant number of property developers, driving some businesses to a grinding halt and others to the brink of failure.
There’s a combination of factors at work here creating a perfect storm for developers:
APRA’s Macro-Prudential Lending Guidelines
The requirements of Basel 4 by 2020
Retail banks withdrawing from taking any construction risk
Withdrawing the offer of mortgages to SMSFs and FIRB buyers and
Not offering interest-only mortgages to investors
The story is most easily told through the experience of a developer who, two years ago, sought and obtained funding for the construction of 20 residential units.
At the time, to meet the lending criteria of the bank, the developer, confident that FIRB purchasers would obtain funding, was able to sell 10 to 15 per cent of the stock to foreign buyers and openly target the direct investor market, including SMSFs.
Two years on the project is complete and the developer is looking for purchasers to settle.
And this is what the developer now confronts:
No major retail bank at present will fund a foreign buyer resulting in three of the 20 units failing to settle. Normally, this would not be a major concern as settlement on the remaining units would clear the existing debt but the three units that did not sell represent the developer’s profit and equity invested which, often, is turned back into a new project.
Sales on another three of the 20 units would have been placed by SMSFs. Today, major retail banks will not provide the settlement funds for SMSF purchasers. Another three of the 20 units now fail to settle and the developer is now facing an inability to reduce the construction loan.
Of the remaining 14 units, six or seven would have been bought by individuals or entities intending to borrow interest-only. At the time, given a suitable deposit, such buyers had every confidence that an interest-only loan would be approved at settlement. Most of these buyers calculated very carefully their ability to service a loan taking into account negative gearing and, over time, anticipating possible capital growth. These buyers have been hit from two sides: they are now being expected to ante up larger deposits than they were originally told was acceptable because debt-servicing ratios have changed significantly. Additionally, some banks are now refusing to offer anything other than a principal and interest loan. For some buyers, that reality increases their repayments by more than 60 per cent.
The ultimate outcome is that buyers who lack the income to service both principal and interest are forced to sell, usually at a discount.
At the same time, the developer is attempting to resell the units initially bought off the plan by both foreign buyers and SMSFs.
The developer is caught, as are the purchasers who are capable of settling, but who, to dispose of their risk, opt not to settle, instead, to sell at a discount.
That then affects the value of the units that are being settled, resulting in those purchasers having to find larger deposits to secure funding.
Our experience currently is that many residential property developers are currently facing serious financial predicaments. As a result, developers will need to:
Have a balance sheet and sufficient capital to fund their own projects
Undertake only specific developments where it’s likely that potential purchasers either have cash to settle or are conscious that they will be borrowing Principal and Interest loans
Look to specialist funders outside the retail banks; or, worst of all, withdraw from the market completely.
Unlike the aftermath of the GFC, there are options today: there are many non-bank lenders willing to offer alternative and affordable funding but, for some developers, this is a step too far.
Having relied for years on the retail banking sector for funds, they have failed to see that there are alternatives to the unpredictability of the major banks’ lending criteria.