Australia’s largest apartment developer and owner, Meriton’s Harry Triguboff, has called on me to alert Australia that next year we could face a real estate crisis similar to the 2007 US disaster that triggered the global financial crisis.
Triguboff warns that if the triggers that have been inserted in our system are pulled, it will cause a significant fall in Australian dwelling prices and substantial bank losses, as occurred in the US but, of course, we will not trigger a global financial crisis.
I must confess I had not appreciated neither the dangers the nation now faces nor the controversial lending practices of the banks that now endanger our prosperity and the level of our share market.
Let’s start with the fact that we are experiencing the biggest apartment building boom in our history. Just how many apartments are being built at the moment is impossible to calculate but let’s say 20,000 are being built in Sydney, a similar amount in Melbourne and 20,000 in the rest of Australia -- a total of 60,000. The real figure could easily be 10,000 higher or lower.
The major assumption that both Asian and Australian buyers make when they invest is that the migrant-driven, rising Australian population will continue. Any significant slowing of migration to Australia is likely to create surpluses given the huge number of apartments being built. If the population continues to rise, we will need a lot of apartments.
Very few owner-occupiers are buying these apartments. The two main sources of capital are Chinese and other Asian residents who are investing in Australia and private Australian investors.
The Australian investors have paid a 10 per cent deposit and have committed to pay the balance when the apartment is completed. The Chinese and Asian investors have undertaken similar arrangements.
We have all long recognised that if there is a major set-back in China or the region, these overseas buyers might walk away and forfeit their 10 per cent deposits. As a result, local banks have been wary of funding apartment developments with high overseas investor content. Overseas banks have had no such reservations.
That risk is not new and has been accepted by the apartment markets for a long time but, naturally, as the level of new apartment building balloons, the risk increases in size. I hasten to add that the Chinese and Asian Australian apartment buyers show no sign of slowing their buying of Australian apartments and they have been meticulous in honouring all contracts. Harry Triguboff was not alerting me to the above dangers – they’re part of the business. The Triguboff alert comes from a far deeper danger.
Apartment developers around the land, including Triguboff’s Meriton, borrow from banks on the basis of the 10 per cent deposits and the “firm commitment” from investors to pay the balance when the apartments are completed.
But these “firm commitments” from investors are based on commitments banks have made to those investors to fund the purchases. The trouble is that these “commitments” from banks to investors are not commitments at all. The vast majority are at best notice of intention to lend but their contracts have multiple escape clauses and loopholes that mean that the bank support of investor commitments has no legal value.
Our banks are lending huge sums to developers who can only repay the banks if other banks fund their investors but there is no firm bank commitment to fund those investors.
Harry Triguboff spells out this potentially toxic situation in the backing the banks have contracted to give investors:
“The banks can vary the amount of deposit the purchaser has to find; the bank can vary the valuation; the bank can suddenly refuse to abide by the non-binding promise to finance an investor,” Triguboff says.
“I hope that the banks will only use these measures as a last resort, and not often.
“If the banks become unreliable lenders, apartment prices will drop dramatically.”
You could not have a stronger warning from Australia’s largest developer and owner.
The risks of banks walking away or exploiting one of the loopholes is increased by the pressure the regulators are putting on the banks to lower their investor loans and the nervousness analysts are showing toward the ballooning dependence of Australian banks on housing.
And if migration slowed and/or the Chinese became unreliable, then the dangers of Australian banks exercising their loophole escape clauses would be multiplied many times. Once one bank gets the jitters and starts exercising its rights not to fund investors, then the dangers of the others following is multiplied.
In simple terms, Australian banks are playing a very dangerous game by funding developments on the security of loophole ridden loans to investors with clear parallels to the loans US banks made to people who could not pay.
Will the Australian banks exercise their right to escape if they fear that making the loans to investors could create losses? To be fair to the banks, to date they have not excessed their rights except in exceptional circumstances.
Harry Triguboff reminds the banks that they have a huge commitment to the total dwelling market and warns the banks that pulling the plug will have wider effects:
“The value of residential properties that the banks financed in the past, which is where most of their money has been invested, will drop even more rapidly”, Triguboff warns.
That flow on effect on existing apartment values will be multiplied because most of the investment is concentrated on new apartments – that’s where people like to invest their money. If second-hand apartments fall dramatically in value because of the overhang of new apartments where investors have not completed the contract because banks have withdrawn funding, then fasten your safety belts for a nasty situation.
Not only are the bank losses set to be huge but new apartment development will be slashed and its new apartments that are keeping the economies of Sydney and Melbourne (particularly Melbourne) going.
So, when is crunch time?
It’s not 2015. Triguboff says the big decisions will be made by the banks in the second half of calendar 2016. That, therefore, becomes a danger time for bank shares and the stock market
Assuming there is no early poll, that’s when the next Federal election will be held. In some ways the banks are trapped.