Pre-Sales Risks & Funding Issues5 October 2018
It has becoming widely know that funding for buyers seeking to settle pre-sale contracts has become much harder following APRA’s constraints on the banks and impacts from the Royal Commission. Funding challenges are exacerbated by mis-understood valuation techniques, causing some purchasers to default on the contract or to re-sell at a loss. At this stage however, there is no widespread evidence of this in the market. It is worth however pointing out that the valuations banks undertake to support a loan can be very different to the real market value of the property. Banks instruct valuers to prepare the valuation for “first mortgage purposes” with a very specific set of instructions which ensure that the valuer is only able to assess the value from comparable sales of second hand stock (ie not from the pre-sale market) since it is the secondary market that the bank would have to sell into if it took control of the asset. Valuers also pay limited attention to age, depreciation or other quality factors. We all know that when a bank steps into to sell an asset it is usually sold at a discount and so it is not an unusual approach to valuation (though not well explained to buyers). The challenge for the Brisbane market (unlike Sydney and Melbourne) is that the value for second hand stock has not increased much at all over the last 8 years, (chart below) (due to the limited population and economic growth) meaning that comparable prices do not compare well against off the plans prices entered into 3 years ago. In Sydney and Melbourne, however the secondary markets have seen strong price growth and therefore the comparable values still support the contract prices, though this now is likely to change as the market slows. This is clearly one of the major risks of residential development and why having strong pre-sales isn’t in itself enough to cover the market risk of the development. It is also important that consideration be given to whether the funding market will support the sale prices at completion. Understanding the market cycle, when to participate in residential development and how to structure a project to mitigate the market risk are also key considerations. With the right mitigants in place, a residential project should withstand these risks. In the current market, it is harder to mitigate against those risks and therefore I am less likely to recommend a residential development which is seeking to divest all its stock upon completion. This is also why Mirvac and many other groups are looking at the Build to Rent segment of the market which entirely removes the pre-sale risk and allows development (& its associated fee revenue) to continue to support their P&L.