Reserve Bank says residential developers are turning to second-tier lenders – but many are discovering just how unforgiving those loans companies are
To churchgoers at the big evangelical Indian Christian Life Centre, Pastor Moses Singh is a respected leader who travels the world to preach his message. "Am I a giver or a receiver?" he entreated his congregation to reflect last week. "Am I a builder or a puller-down?"
But to his bank, he was just another property developer – and increasingly, the Reserve Bank says, banks are unwilling to finance residential developments unless the properties are all pre-sold, off the plans.
And when Singh and his business partner Sarspati Ruben were unable to get bank finance for the site they were developing in south Auckland, their company Māngere Construction Ltd was forced to look elsewhere for capital.
It's a problem that's dogging the Chinese economy, the Reserve Bank says, and is now spreading around the world. As some large Chinese property developers have run into problems with highly leveraged business models, authorities there have introduced new regulations to restrict financial risks.
Analysis by the International Monetary Fund suggests about 45 percent of China's developers may not be able to pay their debt obligations with current earnings, while about 20 percent could become insolvent.
Here, the numbers of builders and developers going into receivership or liquidation has soared in the past two months. The Companies Office reported 125 such companies going to the wall in September.
“The decline in the property market made it very difficult to find a buyer, and the company experienced a lot of pressure from the second-tier lender.” – liquidator's report
Singh and his family are visiting the Gold Coast this week. But Māngere Construction liquidators Daran Nair and Heiko Draht explain that the loans company became increasingly demanding.
Their liquidators' report says the company was unable to obtain finance for the project except from a second tier-lender, to continue developing a residential property.
"The decline in the property market made it very difficult to find a buyer and the company experienced a lot of pressure from the second-tier lender," they report.
"The company managed to sell the property to avoid further interest and debt to be incurred. The company had no further business activities and it was resolved to liquidate the company."
According to the first liquidators' report, Māngere Construction has no property, no vehicles or equipment, and no cash in the bank – but it's not yet known how much the company owes to creditors.
Singh and Ruben are not alone. First building supplies, then workforce, and now finance – the construction industry has battled a series of challenges that are driving builders and developers to the wall. That jeopardises the industry's attempts to address the housing crisis with the construction of thousands of new homes.
Liquidators tell Newsroom that banks have "virtually ceased" lending to developers. "Developers have no choice but to seek second-tier lenders, and they have draconian provisions in their lending arrangements – not just on the interest rates, which are currently at 10 to 15 percent," says one.
"With the decline in property prices, developers are unable to complete the project and make a profit out of it. And that's one of the reasons why they choose to put the company into liquidation."
The Reserve Bank's Financial Stability Report, published this week, says a slowing in residential construction would weigh on broader economic activity and employment.
The number of new houses being sold off the plans has declined considerably, it says. "Since a high level of pre-sales is a prerequisite for obtaining finance from lenders, developers are potentially facing a substantial slowdown in activity once currently committed development pipelines are completed."
“It is possible that a further slowdown in housing market activity could put some development projects funded by non-deposit takers at risk of being unable to be repaid in full.” – Reserve Bank
Although new dwelling consents are being issued at record levels, the number of those buildings that are being completed has fallen in the past year.
"With the recent fall in prices of existing houses, developers are experiencing lower demand for new projects and are struggling to obtain enough presale commitments to be able to obtain finance for projects.
"Some developers that acquired land at high prices face the prospect that previously viable projects are now unlikely to proceed, leading to potential financial losses. Alongside the high cost of building materials, these factors mean that the supply of new builds beyond projects that have already been committed to will slow."
The report notes this is creating "acute downside risks" for the residential construction sector.
Buyers have been scared away by projects such as Onehunga's $85m Beachcroft Residences grinding to a halt, leaving those who bought off the plan potentially out of pocket.
"Buyer enquiries for residential pre-sales have declined heavily as the perceived risks in purchasing off-the-plans properties grows, given declining prices for existing properties and ongoing construction cost inflation," the Financial Stability Report says.
Like other businesses, residential developers continue to face a shortage of suitably skilled labour and high inflation in the cost of materials, and with less confidence that any cost escalation can be offset by the final price as would be the case in a rising market.
The number of construction and property development company failures has picked up, the report says, but remains low relative to the approximately 70,000 registered companies in the sector.
More builders and developers in trouble
Despite the acute challenges facing the residential construction sector, the report says the Reserve Bank has not yet seen a material deterioration in banks’ asset quality. Rather, developers have turned to non-bank lenders to obtain the necessary finance to complete existing projects.
"Non-bank deposit takers are more willing to fund development projects with lower pre-sales or that have properties that get sold after being completed – ‘spec’ or ‘turnkey’ housing. Developers may also use a combination of bank and non-bank finance structured in a way to meet the risk appetite of both types of lenders, for example through subordination," the report says.
"Market contacts have reported that as the housing market has slowed and pre-sales have fallen, overseas investment funds are also playing an increasing role in financing residential development projects."
But it issues a warning: "It is possible that a further slowdown in housing market activity could put some development projects funded by non-deposit takers at risk of being unable to be repaid in full."
The report says residential development loans are inherently high risk. "A deterioration in loan performance could materialise as loans reprice and firms exhaust the list of viable projects."
It adds: "A widespread failure and exit of firms in the construction sector would restrain future growth in housing supply, hindering the rebalancing of house prices with their sustainable levels. In turn, this could lead to a future build-up of over-valuation and financial stability risks in the housing market."
