The Reserve Bank of Australia has warned that settlement risk on apartments purchased off-the-plan may have increased as a direct result of the stricter criteria that banks are now applying to investor housing loans.
In its Financial Stability Review for October, released Friday, the Reserve Bank said that despite the recent targeted adjustments to investor loans, banks will need to remain vigilant in ensuring that their risk appetite and lending practices are appropriate.
The RBA highlighted that risks in residential property development and other commercial property markets continue to build, noting that this area of their lending has been a key source of bank loan losses in the past.
“Risks to residential property developers appear to have increased over the past six months,” the central bank said.
“The large volume of apartment construction currently underway and planned has continued to grow, and the price of development sites has increased rapidly due to strong developer demand.”
The RBA noted that foreign developers have contributed to this dynamic, and are reportedly willing to pay more for development sites than many local developers.
“The risk of a downturn in apartment markets is greatest in the inner-city regions of Melbourne and Brisbane, which look susceptible to potential oversupply,” the RBA said.
“While investor demand appears strong at present, including from foreign investors, apartment markets in these areas already look soft, and future tenant demand, including from international students, is uncertain.”
The central bank highlighted that recent international student net arrivals were less than the Department of Immigration and Border Protection’s forecasts, and the department’s forecasts for coming years have been revised down significantly.
“More generally, population growth has slowed noticeably of late,” it said. “Any downturn in apartment market conditions would weigh directly on the developers’ equity in projects underway, and would increase the risk of off-the-plan sales falling through.
“In liaison, some banks have expressed concern about this settlement risk on pre-sold apartments, particularly in light of the recent regulatory measures aimed at moderating investor demand, though they have also noted that pre-sale defaults have been very limited so far.”
The Reserve Bank said a number of banks have already responded to this, and the risk of oversupply more generally, by tightening lending standards to apartment developers in the more “at-risk” areas.
The RBA’s comments come after a national property advisory firm last week warned investors to avoid off-the-plan purchases, claiming they are “fraught with danger”.
David McMillan, director of acquisitions at Performance Property Advisory, said an oversupply of off-the-plan apartments, falling property values and recent regulatory changes by APRA will begin to affect purchasers in the months ahead, and believes Melbourne is particularly at risk.
“For a start, it has too many off-the-plan apartments and not the available rental population to make this type of investment worthwhile,” he said.
“In addition the value of generic off-the-plan high-rise, fringe house and land packages has fallen by 10 per cent to 15 per cent in some pockets of the city, and now with APRA changes beginning to take effect and the big four banks requiring a 20 per cent deposit, those with off-the-plan contracts will have to stump up additional cash to settle.”
Mr McMillan said the problem with off-the-plan property is that there is a significant time lag between purchasers making the initial deposit and settlement – sometimes up to three years.
“What this means for investors, who say, put down a 10 per cent deposit on a $1 million apartment, they will now need an additional $100,000 to settle,” he said.
While Mr McMillan welcomes the changes made by APRA, saying they will moderate an overheated market, he noted that there will be collateral damage.
“Those most affected will be people who can least afford it – often those close to retirement who have used their life savings to purchase property via their SMSFs.”
Mr McMillian noted that the finger should be pointed at unscrupulous advisers, accountants and financial planners for herding their clients into risky investments because they stand to pocket commissions of up to nine per cent on the purchase price of the property.