The excess of residual stock on the residential market is causing a few headaches for developers, especially when looking to finance their next project. Here’s why: banks are constricting their home loan appetite to foreign purchasers, so investors who made assumptions on criteria 18 to 36 months ago may now face difficulties financing their off-the-plan purchase – and be at risk of defaulting.

The regulators at APRA have also had an impact on the decision by banks to raise investor rates. There’s also talk of lowering leverage for local investors, which will potentially exacerbate the oversupply issue.

And with low rental yields, banks are reluctant to provide loans on residual stock. Their servicing metrics measure how the property income can service the interest on a loan, and current residential yields in all states mean your development is unlikely to meet these metrics – even if fully leased.

Think first before you lease or discount

While there are a number of short-term solutions out in the market, none guarantee a decent return for the developer.

Leasing the excess stock isn’t ideal for obvious reasons – namely, there is a premium for buying a brand new apartment, just like driving away a new car. If you put tenants into an apartment, it will no longer be able to sell that at that price in the short-term – plus it’s harder to arrange inspections.

Meanwhile, discounting erodes the security pool. If you sell a $500,000 apartment for $450,000 it sets a precedent for the remainder of the stock in the development, and can have a negative value impact.

That said, selling stock is how we get repaid so a developer ‘meeting the market’ is sometimes a necessary evil. It’s also why we tend to gear to a maximum 70% to 75% to allow for this scenario.

Investing in the long game

However complicated as the current market may be, there are alternative financing options that are worth investing in for an ideal long-term outcome.

Here’s an example. Recently, we had a client with a 100-unit project coming to completion (Project A) and another development site under option (Project B):

  • The option on Project B was vesting and the developer needed $10million to complete on the purchase.
  • 75 of Project A’s apartments were sold off the plan, of which 70 had completed ­– this repaid the bank and other secured creditors.
  • We managed to fund a $12million facility against the residual stock, which allowed the client to settle on Project B. It also provided working capital to pay the project marketers and consultants so they could get the project off the ground.
  • The remaining 30 apartments were worth around $20million. So we lent our client 70% against the residual stock, including capitalised interest.
  • That allowed him to avoid flooding the market with the remaining 30 apartments on completion, and he could sell down in an orderly manner and realise optimal value.

As a rudimentary guide, over an 18 to 24 month period a developer generally doubles the capital they put into a project. If you can release equity at, say, 10% to 12% per annum you’ll effectively get three or four times that return, by putting that capital to work in the next project.

Our new financing solution will lend up to 75% against the individual strata values, with no discount applied – releasing up to 20% more capital to the developer.

If residual stock is an issue you are facing, please get in touch as we would love to help.