Developers, non-banks behind property bubble
The Australian 12:00am April 8, 2017
Alan Kohler
The regulators are cracking down on bank lending, but they may be missing the mark.
A property financier — not a bank — told me this week that developers don’t argue about interest rates these days; the only negotiations are about the loan to value ratio and how quickly the money can be approved.
The interest rate this guy charges is 13 per cent, take it or leave it. Others are the same. They always take it. The LVRs average 60-65 per cent, although the numerator (the value) can be a bit wobbly before the project starts, and most of the non-banks can approve the funds pretty quickly: they don’t usually have boring credit committees to worry about.
There has been a bank credit squeeze for residential development for 18 months, ever since the Australian Prudential Regulation Authority restricted investor lending growth to 10 per cent.
But if you squeeze a balloon at one end it will bulge at the other end, and the bulge is a new class of non-bank property development funders, who are paying for the explosive growth of apartments in Melbourne, Sydney and Brisbane.
They raise money from high net worth individuals and small institutions at 8-10 per cent interest and lend to developers it at 12-14 per cent, who are happy to pay the interest because they are confident of turning the apartments over quickly, and in fact they are usually pre-sold.
But at least it’s new housing, adding to supply, and for that reason a good thing — working against the big problem in real estate at the moment, which is soaring prices and crashing affordability.
But it’s also a game of musical chairs, and when the music stops quite a few of them may be without a seat.
The buyers are often Chinese looking to get cash out of teetering China and those who aren’t are getting interest-only funding from banks on 80 per cent LVRs, or higher, deducting their investment losses against other income and getting a capital gains discount at the end.
It’s hard to imagine there won’t be a pile-up at some point, although (to switch metaphors) it’s also hard to figure out who gets left holding the baby at the end — the developers, the funders, those funding the funders, or the investors? Or all of the above?
But at least the banks will be unquestionably strong — “fortune favours the strong”, to quote the chairman of APRA Wayne Byers, in turn reading from the Murray inquiry’s phrase book. Byers and the others on the Council of Financial of Regulators, including RBA governor Philip Lowe, are only worried about the banks, for which they are directly responsible. But they are failing to learn from history.
The Australian property collapse of the 1980s and the American crisis of 2007-08 were not caused by banks, but by non-banks.
In Australia it was the building societies and a merchant bank named Tricontinental, funnelling yield-hungry investors into high interest rate mortgages; in the US it was Wall Street investment banks bundling up mortgages into high interest rate packages for yield-hungry investors.
Is something like that brewing here again? Maybe, maybe not: at around 60 per cent the LVRs provide a 40 per cent buffer for the lenders if the developer defaults and prices collapse because a lot of developers default at the same time.
But you’d have to think it wouldn’t be great for the economy if developers were wiped out en masse, and how many of the non-bank financiers are lending at higher LVRs than 60 per cent?
It’s impossible to say because no one seems to be taking much notice. Are the regulators even aware that having imposed a credit squeeze via the banks that the other end of the balloon is bulging?
And how ironic would it be that with the government and property economists pleading for more housing supply, it’s the huge increase in new housing supply that causes the eventual crisis?
In other words, it may not be the boom (which some call a bubble) in existing house prices in Sydney and Melbourne that causes Australia’s next financial crisis, or even the interest-only loans by the banks to help the investors with their negative gearing.
Instead it could be the inevitable supply response from developers and their non-bank lenders.
As Mark Twain is supposed to have said: “History doesn’t repeat itself, but it often rhymes.”