August 2, 2017
Is now the time to worry about settlement defaults?
As regulatory pressure on lenders intensifies, and a significant volume of apartment developments near completion – settlement default is becoming an increasingly common topic of conversation. It poses a big risk for developers, who are faced with the challenge of protecting their investments in a volatile and potentially deteriorating market.
Purchasers at risk of default
Local buyers and owner-occupiers tend to follow through with their settlement – even when their valuation comes in below purchase price, or when their lender LVRs have reduced. In large part this stems from the fear of being personally pursued (and rendered potentially bankrupt) for failure to complete their contract.
An offshore investor buying off the plan is far more likely to default. Typically, foreign buyers back out for one of the following reasons:
Lower property values
Inability to procure finance (sometimes in any form)
Reduction in liquidity, with some governments limiting the amount capital individuals can send offshore
The unlikely risk of facing legal recourse if they fail to complete.
As more stock is delivered and regulatory authorities and government bodies develop stricter policies to contain housing prices, settlement default is set to become an even larger issue.
Supply, demand, and a twist to the duty
When it comes to settlement, valuations are critical. In some markets, where we see property prices decrease as areas become oversupplied, valuations are now coming in lower than original off the plan purchase prices.
For local buyers, valuations are normally a financing tool. But for foreign investors, valuations are an insight. If your foreign investor’s valuation is significantly below their purchase price there is a high risk of settlement default.
As more foreign investors reassess their investments, and potentially decide to walk away from their contracts (using their deposit as an option fee), more developers are faced with the challenge of tackling this serious issue.
Recent changes by some State Governments to increase foreign purchaser stamp duty, plus local banks not wanting to recognise these sales in their credit assessment can only work to cripple off shore apartment sales.
This is very much a case of shutting the gate after the horse has bolted – the medium-term risk is reduced development supply, and the housing affordability issue is sustained.
Finance market squeeze
Tough restrictions on lenders over the last 18 months or so have seriously impacted the availability of capital. The Australian Prudential Regulation Authority (APRA) has introduced and regulated policy to limit bank credit growth in mortgages on investment and interest only loans.
Added to this, banks now typically require investors to contribute equity of up to 30%, where previously they may have only had to contribute 10-20%. This is causing some purchasers to fail on settlements, as they can’t acquire the equity that is required by the banks.
Safeguard your investment
Smart developers are thinking ahead by communicating with their purchasers early and more often. By implementing a process of continuous engagement with buyers, developers can advise buyers of any changes to lending practices by the banks and prepare them for settlement well ahead of the forecasted completion dates.
Some are going a step further by introducing buyers to lenders or brokers who can assist with financing.
Stamford Capital is providing alternative financing solutions for developers facing residual stock issues, allowing them to release some capital without resorting to discounting.
Even at low LVRs, the local banking market has little incentive to provide funding for developers holding stock. The banks, and for that matter APRA, are highly conscious of interest cover, which is not great for when developers want to hold stock vacant for marketability and ease of sale.
Stamford Capital prides itself in making all possible efforts to ensure that any residual stock held by developers is financed at a reasonable interest rate.
Prepared for the demand.
Stamford Capital has been increasingly active in assisting foreign buyers in obtaining finance at a time when APRA and the banks have been tightening the ability of these buyers to obtain funds.
We foresaw what APRA and the banks would be doing in terms of restricting lending to foreign purchasers before the restrictions started to set in. As a result, the group was better prepared for the demand for funds by foreign buyers when the restrictions began to be implemented. By actively working with developers, we have been able to provide funding lines tailor-made to their projects and foreign purchasers.
We also recognised the need to form strong relationships with non-bank institutions and the need for these same institutions to fill the void that was occurring. The group always set out to make sure that foreign buyers would be able to actively participate in the Australian property market. Together with these non-bank funders, we have been able to consistently deliver innovative finance products to foreign buyers.
Of course, sometimes settlement default cannot be helped. Developers establishing a strong line of communication early with their purchasers is the key. The sooner developers become aware that a buyer is having difficulty in settling, the sooner the developer can assist the buyer in obtaining finance sooner or relisting the property for sale if obtaining finance proves to be impossible.
If you’d like further advice on safeguarding your investments, please get in touch.