The Australian Bureau of Statistics published building activity data this week which showed there were 227,122 dwellings under construction nationally, only slightly lower (0.6%) than the record high set over the March quarter earlier this year. 69% of these dwellings were classified as ‘other residential projects’ which are predominantly apartments. Three quarters of these new apartment projects are located in New South Wales (66,511) and Victoria (50,085).
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. With so many units in the pipeline at a time when overall housing market conditions are weakening, settlement risk is heightened.
Settlement risk refers to the risk that the purchaser of a property isn’t able to meet their settlement obligations and subsequently the contract for purchase may not settle. Settlement risk is inherently higher for an off-the-plan purchase due to the long time period between signing the contract of sale and the completion of the project prior to settlement. Market conditions and personal circumstances can change materially between these two dates. Off-the-plan buyers would of course be hoping the value of property rises during the settlement period, and this has certainly been the case in Sydney and Melbourne during the growth phase.
The unfortunate reality is that dwelling values are now falling and for some off-the-plan buyers, the value of their unit at the time of settlement could be lower than the contract price. Metadata from CoreLogic’s Valex platform highlights this trend. In Sydney, 30% of off-the-plan unit valuations were lower than the contract price at the time of settlement in September, double the percentage from a year ago. In Melbourne, 28% of off-the-plan unit settlements received a valuation lower than the contract price. In Brisbane, where unit values remain 10.5% below their 2008 peak, the proportion was substantially higher, at 48%, although the trend is easing due to the unit construction cycle peaking two years ago and much of the unit supply now absorbed.
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. 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. Some buyers may simply not have the funds to do so which could see the contract fail to settle.
Additionally, some buyers may simply be reluctant to settle on a property that is now worth less than what they originally thought. Im not a lawyer, but contracts of sale are generally tight. Buyers who aren’t able to settle or choose not to settle would likely lose their deposit and could be sued by the developer to recover any costs incurred, including any difference between the contract price and ultimate selling price.
With the unit construction cycle moving through an unprecedented peak, the settlement phase will be an important facet of the market to monitor.
Markets where unit supply has been high and market conditions weak have seen a surge in loss making re-sales. Brisbane and Perth are prime examples, with loss making apartment re-sales substantially outweighing loss making resales for houses. An oversupply of inner city apartments has seen a divergence in Melbourne as well, however stronger housing market conditions across the city have helped to keep a lid on more substantial instances of loss as seen in Brisbane and Perth.
As new apartment supply reaching settlement peaks in Sydney and Melbourne, amidst weaker housing market conditions, tighter finance, fewer domestic and foreign investors and sublime rental conditions, we could see loss making resales across this sector trend higher as well.