Buyer’s Agent: Developer’s panicked by Chinese shut-out

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Cross-posted from the Secret Agent:

The development space in inner Melbourne and Sydney is set to be severely challenged. Conversations between Secret Agent and various developers over the past month have revealed their increasing anxiety about potential settlement issues. These developers, who have settlements due in the next 18 months, are worried that many of their apartments may not be able to settle due to the restrictions placed on foreign buyers by local banks. This is likely to have substantial implications.

For some time now, developers have used successful business models to sell their projects directly to Asia. Sales companies who specialise in selling unseen apartments to the Chinese market have made large financial gains. These apartments, many of which are tiny by local standards, have been purposely designed for the overseas market. Committed contracts, once thought to be rock solid, are now on shaky ground.

To understand the problem at hand, let us consider a hypothetical situation. An investor group, on behalf of a developer, sells a small two bedroom CBD apartment to a buyer based in Shanghai. The buyer pays $714,000 for the 68sqm apartment, which is $10,500 per square metre, and pays a 10% deposit. Since the transaction was entered into 12 months ago, the investor has no stamp duty to pay at settlement. It so happens that this purchaser defaults. The developer gets to keep the 10% deposit minus fees. The problem is that there is a need to sell the apartment to someone else.

The product is now competing within the secondary market, which according to Secret Agent’s square metre index, is priced at $8,463/sqm in Melbourne CBD. This makes the unit worth approximately $575,500, meaning there is a shortfall of $138,500, not including professional fees and commissions that also need to be paid. Recouping of the deposit would bring this back to $67,100. However, after paying out commissions to the agents, the developer would most likely be closer to losing $100,000 for each apartment that fails to settle.

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The design of the apartments has not been tailored to the local market, which makes it harder to sell. The overseas buyer that can still purchase it under limited circumstances would now have to pay stamp duty plus a further foreign purchasers levy of 7% which is set to come into the market in July 2016. This means that $87,890 would need to be paid in additional fees by a foreign buyer purchasing the unit at settlement. This is unlikely. The developer has a right to claim a shortfall in price to the defaulting purchaser, however this might be extremely hard to do when committed contracts have originated from countries such as China.

With most of the local major banks out of the market, there is hope for developers that Australian domiciled Chinese Banks will take on the lending to buyers. However, the current loan ratios are unlikely to be favourable and the valuations of the apartments might push foreign buyers to drop their deposits and not settle their contracts at all.

At Secret Agent, we have our doubts whether many of these buyers understand their contractual obligations. We also believe that many developers are not aware of who these buyers are. This only adds to the problems already highlighted. It is easy to see why developers are feeling anxious when considering the losses that could ensue if their settlements don’t go through. The repercussions might go much further. The banking sector and the entire economy will be tested should settlement risk not be contained.

As they say at every auction these days, it’s only money!

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.