Managing property development risks associated with the Banking Royal Commission

Tighter restrictions on mortgage lending could increase risk to property developers.

This is according to RiskWise Property Research CEO Doron Peleg, who says the impact of any recommendation by the Banking Royal Commission to tighten lending could lead to some areas and property configurations carrying higher levels of risk for property developers.

“The Banking Royal Commission has found the current processes for ensuring prospective home loan customers provide true information regarding their incomes, expenses and debts, are flawed,” Mr Peleg said.

 

“This includes the details that are gathered by mortgage brokers, who generate about 50 percent of the loans, regarding the living expenses customers provide in their home loan applications.”


Banks are already applying greater scrutiny to the living expenses declared by customers in loan applications. Westpac has recently written to brokers informing them it will require customers to hand over more details about their spending when applying for a mortgage, breaking it down into 13 different categories, up from six.

“In the short term at least, this is likely to result in a lower volume of loans, as seen in the UK which had a 9 percent drop in volume as a result of the 2014 Mortgage Market Review (MMR) to address lax lending standards,” he said.

 

“It is also likely that the duration to approve loans will be significantly increased, and significant reduction is projected in borrowing capacity (as per UBS housing borrowing capacity could be cut by 21-41 percent, depending on the borrowers’ income).

“But the major question is which areas, property types and configurations will carry higher levels of risks for property developers and, more importantly, how to manage these risks.”

 

Overall, the following carry a higher level of risk. These are areas that experience low economic growth and poor population growth; high-rise unit blocks; properties that appeal particularly to investors; and unaffordable areas and properties at the top end of the market.

Major actions to manage risk:

1) Minimise your exposure to areas that experience low economic and population growth, and overall low demand for dwellings. These areas have a higher exposure to price correction. If, as part of your business strategy and / or your operational capabilities, you need to develop in such areas, ensure that the property type and configurations are appealing to owner-occupiers (see more below). You should also have a solid financial plan to hold the properties and rent them out for a number of years, if required.

2) Do not limit your strategic plans to a small geographic area and consider intra-state development, if the risk associated with your preferred area is high. A prime example of a market that carries a relatively lower level of risk is Hobart. This market, and particularly free-standing houses, enjoy strong demand by both owner-occupiers and investors.

3) High-rise units, and particularly those in areas with potential oversupply, such as inner-Brisbane, carry a high level of risk. Unless you have a proven track record and long-term strategy, backed by sufficient capital to manage the risks associated with low demand for such properties, avoid that risk and seek property types and configurations that carry a lower level of risk. Alternatively, consider duplexes and townhouses in suburbs that enjoy strong demand for dwellings.

4) Minimise your exposure to property types and configurations that largely appeal only to investors, (i.e. not suited to families), such as small units. Many investors often use creative financial planning, and they often place strong reliance on cashflow and negative gearing. Therefore, further scrutiny on property investors is likely to significantly reduce their borrowing capacity, and therefore, the demand for such properties is likely to be low.

5) Minimise your exposure to premium / high-end properties and develop properties that appeal to a broader audience. An exposure to properties at the top 20 percentile prices, can result in significant loses. Unaffordable properties at the top end of the market carry a higher degree of risk, as many borrowers need to rely on the current borrowing capacity to purchase these properties. Significant reduction to the borrowing capacity may have a direct impact on these properties.

6) Ensure that your risk assessment results are aligned with the major lenders and the national independent research houses. It is crucial to understand that buyers’ demand specific properties based on:
- Lending approvals and pre-approvals; and
- Media releases and risk assessments by independent research houses, such as RiskWise.If the major lenders ‘black list’ some suburbs / postcodes or if there are multiple media releases from independent research houses that flag a certain area and property types as high-risk, based on their models, this might have a macro-impact on the market. A prime example is high-rise unit blocks in Inner-Brisbane. These are flagged as high risk by both lenders and the national research houses.

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