RBA bullish on apartments despite settlement risks

In its June quarter Bulletin, the Reserve Bank’s Michael Shoory provides an overview of the growth of apartment construction in Australia.

“The increase in apartment construction has reflected a range of factors, including the nature of land supply constraints and affordability considerations, together with a desire to reside in close proximity to employment centres and amenities,” Mr Shoory said.

“Given that these factors are likely to persist, apartments are expected to continue to play an important role in providing new housing supply.”

Apartments accounted for one-third of all residential building approvals last year.

Fears over settlement failures have been mounting following a crackdown on foreign buyers, who have been a key driver of new dwellings demand.

Banks have also added more limits on the number of foreign-buyer pre-sales developers can use before obtaining finance for new projects.

Mr Shoory said banks typically cap the share of a developer’s pre-sales that can be accounted for by non-residents, generally at between one-fifth and one-third of the value of debt obtained.

With lower LVR limits to investors and the introduction of tighter credit controls on new purchases, settlement risk has become a major worry in recent months.

Lenders do not formally assess debt serviceability or provide unconditional financing approval until settlement is ready to take place.

“If the amount the lender is willing to lend is significantly less than the purchaser expected when they entered into the off-the-plan contract, the purchaser may be unable or unwilling to settle, in which case they would be liable to forfeit their deposit,” Mr Shoory said.

“This settlement risk is magnified if prices (for similar apartments) have declined over the development period (leading to valuation below the purchase price) or if the buyer’s financial position has deteriorated (in the event of unemployment, for example),” he said.

“Instances of buyers failing to settle their apartment purchase – settlement failures – can affect the financial position and credit risk of apartment developers, leading to potential losses for lenders.”

However, despite these risks, the central bank is confident apartments will continue to play an important role in the future.

“Apartments have driven the increase in new dwelling construction in Australia since 2010 and have provided an important contribution to economic growth and employment,” Mr Shoory said.

“Apartments are likely to continue to play an important role in providing new housing as land supply constraints motivate prospective home owners to purchase higher-density dwellings (which use land more intensively and are therefore less expensive relative to larger, lower-density houses), and as tenants and residents choose to live closer to employment centres and amenities for convenience.”

[Related: Developers given a lifeline as lender reveals new offering]