The RBA is worried about the increased risk to property developers from tighter lending standards

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  • The biggest risk to the Australian economy from tighter lending standards is not the impact on households, but rather property developers, according to Guy Debelle, Deputy Governor at RBA.
  • He says tighter lending standards for home borrowers “could lead to an increase in settlement failures, further price falls and even tighter financing conditions for developers”.
  • Given recent liaison with developers, Debelle says that “few have reported much evidence of this”.

The biggest risk to the Australian economy from tighter lending standards is not the impact on households but rather property developers, says Guy Debelle, Deputy Governor at the Reserve Bank of Australia (RBA).

“There has been some tightening in credit for developers of residential property. This reflects lenders reducing their desired exposure to dwelling construction, which is higher-risk lending, particularly given the longer planning and construction lags of higher density dwelling construction,” Debelle said at a FINSIA event in Melbourne today.

“That is, banks are less willing to lend given the fall in prices.”

At a time of tighter lending standards for prospective home borrowers, limiting demand from investors and contributing to weaker home prices, Debelle says the flow on effect has “indirectly affected developers’ access to finance”.

Given an expectation that residential building will remain strong at least a year, reflecting previous strength in housing market conditions and building approvals, Debelle says “there is a risk” that tighter lending standards for home borrowers could “lead to a sharper or more protracted decline in activity” in the residential construction sector.

“One risk is that tighter lending standards could amplify the downturn in apartment markets if some buyers of off-the-plan apartments are unable to obtain finance,” Debelle said.

“This could lead to an increase in settlement failures, further price falls and even tighter financing conditions for developers.”

Although this remains a risk, given recent liaison with developers, Debelle said that “few have reported much evidence of this”.

However, while developers have managed to weather the downturn so far, the risks outlined by Debelle are increasing in Sydney and Melbourne, in particular, given the combination of falling prices and strong supply of new apartments nearing completion in these cities.

According to data from CoreLogic, 30% of newly-completed apartments in Sydney, and 28% in Melbourne, settled in September with a valuation less than their original contract price, reflecting the impact of the sudden reversal in housing market conditions over the past few years.

“Many of these apartments would have been sold off the plan, at a time when housing conditions were much stronger and credit conditions weren’t as tight,” said Tim Lawless, Head of Research at CoreLogic.

As alluded to by Debelle, Lawless said the combination of record new apartment supply and falling prices means that settlement risk is now “heightened”.

“Off-the-plan buyers who find their valuation comes in lower than the contract price at the time of settlement could be in for a rude shock,” he said.

“Lenders will generally be looking for a loan to valuation ratio of at least 90%, more often closer to 80%, meaning their deposit will need to be at least 10% and potentially closer to 20% of the property value.

“If the valuation comes in lower than expected, the buyer may need to top up their deposit in order to meet the lenders loan to valuation criteria.”

Under such a scenario, Lawless said that some buyers may not have the additional funds required, potentially seeing the contract fail to settle and the loss of their initial deposit.

While in isolation that shouldn’t be a major concern for developers, on a large enough scale it could exacerbate the downturn in prices, making it harder to finance new projects, refinance existing facilities and, in some instances, a lift in insolvencies.

A recent report from Ernst and Young (EY) Australia warned that Australia’s property industry was facing a downturn not seen in 30 years, meaning property developers should be taking measures to protect themselves.

“Shrinking profit margins may prevent developers from recycling capital and profits into future existing projects which may put those projects in jeopardy” the report said.

“This could lead to an increase in ‘fire sales’ which will re-set the market and cause further concern from a finance perspective.”

Given the potential financial and economic risks from a steep decline in residential construction, it’s an area that will be monitored closely.

The full speech from Debelle can be accessed here.

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