Major cities may see off-the-plan purchases fail

According to the RBA’s Financial Stability Review, which is released semi-annually, a “large number” of new apartments has started to come on line, and as more completions are expected in the coming two years, this could see increased risks in several major Australian cities.

The report reveals that risks “appear greatest” in Brisbane and Melbourne’s inner-city suburbs, where the pipeline of construction is large relative to the existing dwelling stock, and where conditions are fairly subdued, especially in Brisbane where rents are now falling.

Further, the slowing in mining investment and the fall in commodity prices are leading tenants to vacate offices in Perth and Brisbane, depressing rents further in these cities.

The RBA has revealed that one risk associated with the large volume of construction underway is that off-the-plan purchases fail to settle.

The report reads: “Liaison with the property industry points to some concern that this will become more common in Brisbane, Melbourne and Perth.

“These concerns arise from a combination of tighter financing conditions for purchasers (especially for non-residents and those reliant on foreign income) and valuations at settlement below the contracted price.

“Liaison with banks and industry suggests that in Melbourne, and increasingly in Brisbane, valuations for off-the-plan apartments are often a little below contract prices. However, the magnitude of the difference varies across individual projects and apartments…

“In weaker markets, such as Perth, there have been some instances of developers offering discounts to contracted prices to ensure that settlement occurs. In some cases, larger developers have also offered vendor finance to foreign buyers who could not access bank finance.”

The bank also revealed that in Perth, the expected flow of new dwellings is “more modest” relative to the stock and is geographically dispersed, but “these dwellings are entering the market at a time when housing prices and rents are falling and population growth is slowing”.

Purchasers facing finance difficulties

Indeed, the report outlines that housing price growth nationally is “slower than it was a year or so go”, but has “picked up a little” in Sydney and Melbourne in recent months, due in part to “the ongoing search for high-yielding assets in a global environment of low interest rates”.

Nonetheless, the bank suggests that settlement failure rates to date remain low, “although settlement on some projects is taking longer as purchasers are having more difficulty arranging finance”.

The RBA also highlights that the banks’ tightening on lending standards and “greater difficulty achieving the required level of pre-sales” have led some developers to adopt buyer incentives, delay their building projects, or, in severe cases, sell their development sites.

However, it suggests that as some developers have funded new apartment projects through bank debt (increasing their leverage and leaving them more vulnerable to a downturn in apartment markets), the banks have had to tighten financing conditions for new developments over the past six months through “stricter pre-sales requirements, lower maximum LVRs and stricter geographic concentration limits” to mitigate the risks on this lending.

According to the bank’s report, the pick-up in the non-performing housing loans ratio has been almost entirely in past-due rather than impaired loans, suggesting that, at current prices, banks generally expect to recover the full amount of their loans. But it warns that impairments could increase, especially if housing markets in mining regions deteriorate further or if weaker conditions “spill over” further into the broader Perth or Brisbane markets.

The report warns: “If apartment markets were to turn down and settlement difficulties become more widespread, banks would be more likely to incur some loan losses.”

It adds: “Given the significant volume of apartments expected to be completed in the next couple of years, some consequent slowing in construction in some areas could lessen the risk of oversupply…

“It is prudent that financial institutions lend only to borrowers who can afford the repayments and hold adequate collateral.”

[Related: Real estate ‘vectors of distress’ could bring banks down]