At the moment, the crisis is avoidable but soon, without a change in direction, it will become unavoidable and the slump will cover both residential and industrial property.
Earlier this week, I set out just how the APRA credit squeeze works and how it could impact apartments and the economy (Credit squeeze threatens more than just apartments, April 6).
That commentary prompted contact from Meriton’s Harry Triguboff and he provided much more detail about the danger.
And there was also a call from a close student of the industrial property market, warning that the bank squeeze was spreading to that area. Self-managed funds and other private investors have been buying industrial property at low yields unaware of the dangers.
Suddenly it’s become apparent that while APRA may have good intentions in trying to curb the impact of any property crisis on our banking system, because it doesn’t understand what is happening in China, it’s in grave danger of actually creating the crisis that they are trying to prevent.
We are currently seeing Arrium and other smaller resource disasters where the banks got caught in part because they did not recognise the dangers created by a change in China’s direction.
The bank profits from residential and commercial property lending, aided by low bad debts, have helped the banks through their resources difficulties, but now that property boom is in danger of going the same way as resources.
Triguboff explains that Australian banks have been important financiers of apartment developers. His Meriton group is Sydney’s largest apartment developer and owner, so Triguboff has a big stake in the apartment market. But no one knows the market better than Harry Triguboff and for some years he has been concerned that the lending structure of the apartment market has a fundamental flaw.
The banks finance the developers on the basis that those developers have sold their apartments to both local investors and Chinese/Asian investors.
Chinese and Asian investors dominate the market and usually pay a higher deposit than the locals — often up to 30 per cent. But rarely do the local or overseas buyers have a firm financing agreement and this applies to Sydney and Melbourne.
In the case of local buyers, banks have usually indicated that when the apartments were completed they would fund the buyers, but there is rarely a firm commitment.
The Asian buyers believe they will either be able to gain the money from China and/or the local banks to fund the deals.
Triguboff has warned of this structural danger in previous years but the avalanche of money from China and higher apartment prices have meant his warnings never materialised into a crisis.
Indeed, currently the reverse is the case in Sydney and everyone is settling contracts signed 18 months to two years earlier because the higher values makes financing a breeze.
But for those apartments that have been more recently sold, there is no longer a substantial price buffer and indeed in Melbourne ‘used’ apartments have gone to a discount over ‘new’ apartments.
The banks are relaxed because they have not made loan agreements and, as we know, they are constrained by APRA as to how much they can allow their residential portfolio to grow. In addition, there are a series other tighter clamps.
At the same time as this credit squeeze is taking place, it is now much harder to get money out of China, so Asian investors are now much more dependent on the local Australian banks coming to the party.
Fast forward 12 to 18 months and if the banks still have the same lending restrictions and the China clamps remain in place, it will be harder for Asians (and perhaps locals) to honour their agreements.
In theory that should not worry the banks because there is no commitment to the apartment buyer. But many of the developers the banks loaned to will go broke if buyers walk away because of a lack of funding. The banks will have significant bad debts owed by developers. The building industry will crack and there could be a nasty spiral.
APRA, in imposing a credit squeeze at the same as China is imposing a clamp, is endangering the economy.
But it gets worse. The NSW government has sold a lot of land to the Chinese at inflated prices. There is some danger that a number of the deals will fall over because of the problems associated with getting money out of China. There will be similar problems in Melbourne, although the vendors are usually private groups.
At the same time banks have started to be much more cautious in their lending on industrial properties.
My industrial property correspondent sent me the attached graph, which compares rent and industrial property prices. The prices are moving ahead of rents. Self-managed funds and private investors who are concerned about the dwelling and sharemarkets are buying into industrial property, pushing down yields. A wide range of properties are now yielding between 5 and 6 per cent and recently a childcare centre in Sydney sold for a yield of 3.9 per cent. Often there is high leverage involved.
Given the squeeze now being applied by banks, bidding up industrial property is a dangerous investment strategy.
Remember that over the medium term, in both the dwelling and industrial property markets, it is the availability of bank funds that normally sets the prices.
Below is the graph that was sent to me.
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