Avoiding an apartment meltdown

Melbourne’s apartment market is set to feel the full force of any meltdown.

Behind the scenes an incredible drama is taking place in the Australian apartment market as a wide variety of people and organisations try to avoid a meltdown.

During the last week or so I have had the privilege of looking at some of what is happening behind the scenes. We are engaged in a high-stakes game that has never before been played in Australia.

Let me start by explaining what at least some of players are trying to avoid. I now know who “James” is and have determined that he appears to be right that Australia faces the potential of Chinese walking away from apartment settlements at the rate of between $1 billion and $1.5 billion a month for a year or two.

In the worst case scenario a large number of apartment developers go to the wall taking with them many unsecured suppliers. Moody’s is warning that our banks face big potential losses.

Sydney has Meriton’s Harry Triguboff, who went into the crisis without debt but owns some 70,000 apartments. He can cushion the impact on the city. Melbourne and to a lesser extent the already depressed Brisbane will feel the full force of any disaster.

So now let’s look at a number of situations to show what is being done to reduce or avoid the above scenario taking place.

We start with a major apartment development outside the Melbourne CBD. The apartments are of good quality and not the dog boxes that have been built in many places in inner Melbourne. Almost all were bought by Chinese buyers and like most of the other Chinese “off the plan” buyers they can lift their equity from the 10 per cent deposit to 30 per cent. But the local banks will not provide the 70 per cent remaining finance and, even though many have substantial assets in China, they cannot get the required money out to Australia to settle the contracts.

A group is looking to form a consortium of lenders comprising major Melbourne families and various small institutions to help them. The problem is that with so many opportunities available the rates that will be charged will be between 10 and 15 per cent. In this case the developer is a major public company with a strong balance sheet. When the settlements are due and not paid they will almost certainly simply defer them and their balance sheet can stand the pain. Shareholders will have to be told either in February or in August, 2017, depending on when the settlements are due.

In this situation, if the public company were to take ownership of the apartments when the Chinese did not settle, the apartments would become Australian-owned and under present rules could not be bought by overseas Chinese. This is a vital principle for all developers — if your bank financiers will let you keep rolling over the settlements so the apartments remain overseas-owned then they can still can be bought by overseas buyers.

Once apartments become Australian-owned, at least in Melbourne, they are worth much less because the local price is less than the overseas price.

However unsuspecting locals are still being “conned” into paying the “overseas” price.

Enter the Australian property portal for Chinese, Aofun.com.au.

Aofun CEO Jason Zhu has set up an online web site where overseas “off the plan” buyers can sell their apartments to other overseas people who are able bring money into Australia, so avoiding the apartment being classified as Australian-owned when the overseas buyer did not settle.

Zhu confirms that many overseas investors have been “caught out” by the major Australian banks’ decision to freeze lending to foreign investors.

“Many of these potential sellers would have bought an off-the-plan property in the past few years and now find the settlement date looming while they have little or no chance of securing finance” he says.

The Aofun online market place will help but with some 230,000 apartments being built the problem is much bigger.

In the broad, the Australian apartment developments are in three baskets:

First, those being developed by large well-capitalised enterprises like Meriton or the listed apartment developer I referred to earlier;

Second, those being developed by developers with big Chinese backing and funded by Chinese banks. They are highly leveraged;

Third, developers funded by Australian banks.

We do not know the Australian bank exposure but clearly Moody’s is concerned and I have been in contact with funders of new apartment developments that were told by the Australian banks that if they had 75 per cent of Australian buyers they would be funded. Accordingly they obtained permits, secured that level of local buyers and designed the building etc only to find that the banks contacted have lowered the cut off point to 10 per cent---exactly what the local banks did to the Chinese off-the-plan buyers.

Banks reneging on “75 per cent local “ assurances are clearly overextended in apartments and are showing signs of panic.

Meanwhile developers that are nearing apartment completion and realise their Chinese buyers cannot settle are desperately trying to get funding so that they will not have to force settlement and therefore go broke. If an Australian or a Chinese bank pulls the plug on a major developer then the horror scenario I painted above will take place.

In that case, next year bank CEO’s may be required to once again apologise to parliament. But there are consortiums of very wealthy groups including some overseas investors and banks that are trying to work a way through--- but the locals want a 15 per cent return and it will take time.

The developer with 75 per cent Australian buyers may have to take the money at 15 per cent. But that’s an easy one. The vast number of Melbourne small dog box apartments for students are tougher for consortiums to fund.

But the Victorian government now makes it impossible to develop apartments at current prices so no more low-cost apartments are coming. The industry hopes that a crisis can be avoided and the problem be solved over time as overseas buyers are found for what represents a low-cost entry into the Australian market.

And if there is no crisis, Australian first-dwelling buyers will enter the city apartment market on a much bigger scale.