The Australian Lending Journal
ALAN KOHLER
After the GFC, the banks stopped lending to residential property developers; after the BRC (banking royal commission) they have stopped lending to the developers’ customers — investors in new apartments.
That’s an oversimplification, but not much of one.
In 2009 a new industry emerged — “re-emerged” might be more accurate — of non-bank lenders supplying property developers with finance, in the total absence of banks. The post-GFC apartment boom on the east coast of Australia has been almost entirely funded outside the banking system.
The interest rates charged were, and still are, between 12 per cent and 15 per cent, sometimes higher, but developers have been happy to pay such usurious rates because the apartments were selling quickly, off the plan usually, to investors who were themselves enthusiastically funded by banks, often with interest-only loans, and certainly with alacrity.
It meant the expensive money was only borrowed by developers for 18-24 months and the interest cost was easily recovered in the margin on the apartments.
The lenders are a combination of retail mortgage trusts channelling direct SMSF money seeking high-yield alternatives to the falling bank shares, and pure mezzanine finance players collecting larger lumps of family office and high net worth money.
The buyers of the apartments, meanwhile, had relatively cheap bank loans, often interest-only , based on loan-to-value ratios of 90 per cent and more, subsidised by taxpayers through negative gearing.
It has been a tremendous wheeze for almost 10 years and everyone has done well: the original providers of the funds have been getting 8-10 per cent first mortgage yields; the non-bank intermediaries have been getting comfortable spreads of 2-4 per cent; the developers have been making big margins almost riskfree because the banks were throwing money at their customers ; the banks got a solid rebound in credit growth; and the investors got tax deductions and, for a while, capital growth.
This party is now over. Before the royal commission started, APRA cracked down on riskier investor lending, resulting in a steep crash in interest-only loans, a decline in LVRs and increases in interest rates.
Then round one of the royal commission focused on breaches of responsible lending laws in the selling of home loans.
The interim report was scathing of the banks on this subject:
“Much if not all of the conduct identified in the first round of hearings can be traced to entities preferring pursuit of profit to pursuit of any other purpose.
“Lending was treated as not unsuitable if the customer was unlikely to default. But that is not what the responsible lending provisions required. Contrary to those provisions, the banks made no inquiry about the customer’s circumstances , requirements or objectives.”
As a result, the banks have already become much more diligent in verifying borrowers’ actual living expenses, and not just taking their word for it.
That rather novel practice is likely to be set in stone with recommendations in the final report of the royal commission.
More broadly, all the talk of possible jail time has greatly increased the risk aversion of bank boards and executive teams, and as a result they are likely, in future, to use the following comment from the royal commission interim report as a guide for what not to do: “ … for most of the last decade , remuneration arrangements for third party intermediaries and for all staff, both frontline staff and senior executives, have rewarded sales and profitability.
“Doing the ‘right thing’ has not been rewarded. And even in the more recent past, ‘balanced scorecards’ and ‘conduct gateways’ have too often used doing the ‘wrong thing’ as a disqualifying criterion . But penalising default is not the same as rewarding the right and proper performance of a task. Penalising default encourages hiding mistakes; it does not encourage doing the ‘right thing’ . It does not encourage the intermediary or the employee to ask, ‘Should I, should the Bank, do this?’”
The reason that approvals for high-rise apartments (four-plus storeys) are now crashing (down 38 per cent in August) is not that developers can’t get finance — there is still plenty of high interest rate money available from nonbank lenders. It’s because the developers’ customers — negativelygeared property investors — can’t get bank finance anymore and they can’t afford to borrow at the rates on offer outside the banking system, even tax-deductible .
This is a permanent state affairs , or at least it will last a long time, and will be exacerbated, not helped, by the ALP policy of restricting negative gearing to new properties and banning it on existing buildings.
The aim of the policy is to encourage new building, but it will do the opposite. That’s because the purpose of investing in a new property is to sell it for a capital gain, but at that point it’s an existing property and the buyer can’t negatively gear, which means the resale value is much lower, which is known when it’s new.
In other words the resale value problem will mean that Labor’s negative gearing ban on existing properties have just as much impact on new ones.
The only hope for a recovery in apartment construction and continued expansion of housing supply is that big super funds move in and Australia moves to the “build to rent” model that applies in the US and Europe instead of the “build to sell” model that has developed here as a result of negative gearing.
That is, high-rise apartment buildings owned by one investor instead of many — supported by taxpayers through the superannuation tax break instead of negative gearing.
This article is from the October 6 issue of The Australian Digital Edition. To subscribe, visit http://www.theaustralian.com.au/.
Alan Kohler is publisher of “The Constant Investor.”
