NZ’s largest financial institutions including the RBNZ, Treasury and most major trading banks provide forward guidance on NZ house prices as well as wider-ranging macro forecasts for the housing market. While such predictions make for good reading, they are of limited use when making investment decisions. This is because macro forecasts typically fall into one of two categories; unhelpful consensus forecasts that provide little to no competitive advantage, or non-consensus forecasts that are rarely correct.
One only needs to look back at predictions for the housing market in 2020 when covid-19 first emerged. In May 2020, the RBNZ forecasted a 9% decline in NZ house prices, however, by the end of 2020, REINZ was reporting a +17.3% increase in house prices. This is a 26% margin of error from an institution whose primary role is to maintain the stability of New Zealand’s monetary and financial system. In hindsight, one of the key reasons the RBNZ was so wrong was because unemployment levels never reached anything close to what was forecast – they also underestimated the extent to which low-interest rates would buoy the market.
Financial models are only as good as the assumptions made, and in the macro-economic environment, many assumptions need to be made. For this reason, we are always hesitant to make macro forecasts for the housing market. That said, a broad understanding of macro-economic factors can play a critical role in property – particularly when it comes to managing risk. Below we look at credit availability and its impact on the development funding market.
Credit Availability: Sector Wide Credit Crunch
Credit availability describes the amount of funding that is available to the market. Most of the credit is provided via the major trading banks that facilitate investment in property (or other sectors) via investment loans. When banks tighten their lending criteria, funding becomes more difficult to obtain which in turn slows down investment in the sector.
Of late, there has been a significant tightening in lending criteria across all major banks. LVR restrictions, new responsible lending codes, and stricter servicing criteria are recent examples of banks making it more difficult to obtain funding. These changes predominantly impact investors and owner-occupiers who are looking to purchase property. However, we are now starting to witness a flow-on effect for property developers.
Almost all main banks require a project to have 100% presale cover prior to a development facility becoming available for drawdown. However, investors and first home buyers are finding it increasingly difficult to obtain finance on ‘off the plan’ purchases. This is creating an extremely challenging environment for developers who need to satisfy minimum presale requirements before they can draw from a construction facility.
In parallel, there is a general tightening in the development sector as banks take a cautious approach to supply chain issues and material shortages prevalent in the sector. Most banks are requiring increased contingencies in project budgets, higher levels of equity contribution, and key sponsors to have comprehensive development experience before a development facility is even considered.
Non-banks have been a primary beneficiary of banks restricting lending to the construction sector and developers are increasingly looking at alternate funding solutions that will enable them to move forward with their projects. In this regard, non-banks have greater flexibility with their funding lines and can often fund projects without presales, QS reports, and fixed-price contracts (read more about the notable ).
However, over the past few months, it has become apparent that even non-banks are struggling to keep up with the substantial increase in demand.
Having deployed all available funds, many non-banks are now at capacity and unable to onboard new clients or process new loans. In this context, even non-banks are starting to cherry-pick which transactions they fund with the lower risk transactions normally the first to be funded alongside existing client relationships.
To make matters worse, the churn rate (or the rate at which capital is recycled back into the market) is decreasing as delays to construction programmes push out expected repayment dates for projects across the country. Material shortages, inability to procure labour, and delays with council sign-offs and titles are all contributing factors to the current credit crunch.
Most lenders can attest to the increasing number of consented shovel-ready projects that are unable to get out of the ground for lack of funding. We have in previous blogs mentioned that it is prudent for developers to engage with lenders well in advance of funding being required; however, in current market conditions, it is absolutely imperative to do so. Relationships along with past performance will also be key, and developers who have taken the time to build strong relationships with their lenders will be in an advantageous position.
Future funding availability and risk mitigation
Looking ahead, we expect funding conditions to moderate in the medium term. As current projects are eventually completed, new funds will be deployed to the market. In the meantime, developers may have to consider selling down or holding off on starting their projects. To avoid being caught out:
- Don’t take on too much debt, highly leveraged transactions will become difficult to fund as lenders cherry-pick the best transactions.
- Take proactive measures to de-risk your project such as obtaining 50% presales cover (even if not required by your lender).
- Allow for additional project contingencies, more so than you may have in the past.
- Engage with your consultants, builder, and funder as early as possible. Expect delays in turnaround time and build this into your development programme.
- In light of supply chain constraints, discuss alternate products and building methodologies with your architect and builder
Consult with ASAP Finance today for finance solutions
As a market-leading property finance company in New Zealand, ASAP Finance can offer the residential, commercial, or development finance solutions your need to get your development off the ground. Get in touch with our knowledgeable team today for more information.
Stay tuned for our next blog where we take a high-level review of how movements in property prices can impact various sectors within the residential property market.