There’s a lender out there for everyone. The first tier and cheapest are retail banks. They make up about 97% of the housing market but also have a low tolerance for risk. The next layer down are the non-banks. They typically lend on property longer-term and still require borrowers to demonstrate affordability. Then there are the short-term “asset” lenders. Asset lenders only care about the quality of the security and that there is an exit strategy.
Asset Lenders are typically short-term financers for builders, developers and speculators. On the fringe of asset lending are another group who provide even riskier mezzanine funding behind a bank mortgage. These are at very high interest rates (up to 30%) and are in the last resort camp. The amount of lending done by asset lenders has jumped significantly over the past few years and would now be over $1.5 billion.
When it comes to property, the risk is that borrowers (and speculators in particular) think tomorrow will be better than today and don’t act. Watching a speculator in action is like putting a frog in water and gradually increasing the temperature. The frog never jumps out.
Jimmy has a $5,000,000 piece of land that is zoned for future urban development. He bought it for $1,500,000 several years ago for a business. Back then nobody seemed to care about servicing, and he managed to wriggle his way into bank funding. He now owes $2m on it along with a small residential house he bought and he has no demonstrable income. Over the years he’s bought and sold a few properties and made money but that dried up a few years ago. He wants to hold the land for another two years because he believes it will increase in value. If he sold it now, he’d likely only get $4m and a $2m profit because the market is quiet.
The asset lender doesn’t mind a 40% LVR so they lend Jimmy $2.4m to cover lending fees, interest and give him a bit of spare money to cover his living costs. He runs a small business. It keeps him busy and distracted but it doesn’t really make any money.
Jimmy decides the time is not still right and tries to extend the loan. The asset lender isn’t interested but the broker finds another asset lender slightly more expensive who will give them up to $2.8m to cover fees, interest and other costs.
Jimmy can no longer get an asset lender (the loan to value ratio is too high) but he manages to get $200,000 off a mezzanine funder to cover the interest servicing and some marketing costs. He realizes he now needs to sell. Unfortunately, other properties in the area have begun to sell at a discount, so his property is now only worth $4.4m on paper.
There aren’t many buyers for speculative land with no holding income. Jimmy is cornered into selling the property for $3.5m. After costs, he walks away with about $400,000 instead of the $2m he would have got three years earlier.
This story is quietly playing out all over Auckland. There are early signs of ‘speculative’ properties coming up for mortgagee sale. At this stage it’s not enough to validate a bigger issue.
When does the ability to extend and pretend run-out? And if more of these speculative properties need to be sold, what does that do to land prices? Property can be incredibly illiquid.
The nature of speculators is that they must keep moving. They rely on price appreciation, the use of debt, and getting end sales. But increasingly, they cannot keep borrowing, land prices are likely dropping, and end house prices are too high to get sales and exit through development.
At some point, something must give and that will be development land prices and what’s left of speculator’s balance sheets. The winners will be the usual suspects – rich listers who have happily watched from the sidelines. They know it’s not time yet, but things are starting to warm up.
*Jimmy is loosely based around a type of borrower we see.
Interested in finding out your borrowing potential? Use our mortgage calculators to estimate what your home loan repayments would be. Get in touch with a mortgage broker Wellington today to learn more about your personal situation.