Settlement Risk Grows as Apartment Construction Booms 2

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Tuesday, May 31st, 2016
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Risks associated with new apartment purchases not proceeding to settlement upon completion of developments is growing amid a tightening of lending conditions and a massive pipeline of stock which is set to hit the market over the next two years, senior researchers say.

In a recent report, CoreLogic research analysts Tim Lawless and Cameron Kusher warned that ‘settlement risk,’ whereby investors who bought their apartments off the plan may not be in a position to meet their commitments upon settlement, was growing, potentially exposing developers to greater levels of holdings upon completion.

Whereas average sales volumes of new and existing stock combined amounted to around 108,144 on an annualised basis over the past five years, markets are expected to be swamped as a whopping 231,129 newly completed units and apartments come online across capital cites over the next two years.

This means that even if momentum going forward were to continue at current strong levels, demand for new and existing apartments combined – let alone that for new apartments by themselves – would not be sufficient to absorb the volume of stock coming online.

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In addition, Lawless and Kusher say risk is being further exacerbated by other factors, including that:

  • Slower rates of capital growth in the apartment sector relative to that of the detached housing sector mean that many investors who purchased off the plan over recent years may not have experienced the same level of capital growth that they may have been expecting at the time of entering into the purchase agreement.
  • With questions now being raised about whether or not some properties were indeed overpriced to start with, there are fears that final valuations at settlement could come in at lower values than those included in the contract price, meaning that investors essentially faced a situation where they could be underwater from a financial perspective right from the start of their investment.
  • Simultaneously, a pull-back in lending means investors who previously would have been able to borrow potentially up to 95 per cent of the value of the apartment may now only be able to borrow 80, 85 or 90 per cent, and may have to stump up the money to cover the shortfall on their own.
  • Finally, several major banks are now saying that they will no longer lend to overseas home buyers – a situation which could lead to a substantial volume of settlements falling through given the volume of off-the-plan buying by non-resident purchasers.

The danger is most severe in Melbourne and Brisbane, where apartment price growth relative to detached house price growth has been particularly slow, Lawless and Kusher said.

Kusher said the likely volume of transactions which might not proceed to settlement was not easy to predict, but added that the risk was that this could be substantial.

“We’ve got a record high number of units that are under construction and that are coming into settlement and completion over the next twenty four months,” Kusher said. “Obviously, we are testing the market at levels which have never been seen before.”

He said a number of developers could see a significant impact from this.

“From a developer’s perspective, they carry some of the risk because they have people who have agreed to purchase these properties and then at settlement they might simply not be able to settle and may choose to walk away from the contract,” he said.

“Obviously, there are legal fees involved with that, and then they (developers) have got to sell the property as well. If they have to drop the price in order to sell, that could impact the price of other properties within that development, and then you have holding costs as well.

“It can end up eroding your profit on that project pretty quickly.”

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  1. Graham Morrow

    Andrew

    Thanks for that. I am personally concerned with the Perth market, as a complete 'tribe' of cashed up investors has moved interstate or overseas, or no longer earns the super incomes previously available. This further factor may not have, with respect, been identified in your analysis of the Perth market..

    The nature of development is that, as a developer, you take the risks and try and pass these on where you can. Developers need contingency plans if things start to unwind although banks have tightened up significantly on what they can do and will take no risk. A bank may, shortsightedly, push the project to fail and lose more, rather than take any risk at all.

    A developer will be able to keep the deposit money and recover its legal fees where an off the plan buyer fails to complete its purchase,. The developer may have to rent out the apartment to minimise its loses and then sell once the market improves. If several apartments are up for resale immediately, and not all are sold off the plan, the mini glut may drive the apartment price down, a further developer risk.

    Developers, in decreasing risk, may cause collateral industry damage by renegotiating reduced contract sums with builders and subcontractors, extend payment terms or other unsavoury conduct (such as disputing all variations, withholding payment, slowing down on site work where 95% sold has not been achieved, etc). The adverse knock on effect of some developers' conduct should not be underestimated.

    Personally, I cannot see much benefit to clients in buying off the plan where a market is scheduled for oversaturation.

    Regards
    Graham Morrow
    Barrister & Solicitor, Arbitrator and Adjudicator

  2. Excellent article. Have shared it to my LinkedIn page .