Macro Forecasts and Credit Availability

New Zealand’s largest financial institutions including the Reserve Bank of New Zealand (RBNZ), Treasury and most major trading banks provide forward guidance on house prices as well as wider ranging macro-economic drivers of 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.

The challenges of predictions

One only needs to look back at predictions for the housing market in 2020 when Covid-19 first emerged. In May 2020, the RBNZ forecast a 9% decline in house prices however by the end of 2020, Real Estate Institute of New Zealand (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 the forecast – they also underestimated the extent to which low interest rates would buoy the market.

Financials models are only as good as the assumptions made, and in the macro-economic environment there are many assumptions that need to be made. For this reason, we are always hesitant to make prediction about the 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.

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 who facilitate investment in property (or other sectors) via loans. When banks tighten their lending criteria, funding becomes more difficult to obtain which in turn slows down investment into 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.

Cautious approach by banks

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.

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 project. In this regards, non-banks have greater flexibility with their funding lines and can often fund projects without presales, QS reports and fixed-price contracts.

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-bank lenders are now at capacity and unable to onboard new clients or process new loans. In this context, even non-bank lenders are starting to cherry-pick transactions they fund with the lower risk transactions being the first to be funded alongside existing client relationships.

To make matters worse, the churn rate (or rate at which capital is recycled back into the market) is decreasing as delays to construction programmes pushes 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.

Shovel-Ready Projects

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. Under current market conditions, it is absolutely imperative to engage with lenders well in advance of funding being required. 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 and lenders get repaid, new funds will be deployed to the development sector. In the meantime, developers may have to consider selling down or holding off on starting their projects.

Some tips

Some tips to avoid being caught out: (a) Don’t take on too much debt, highly leveraged transactions will become difficult to fund as lenders cherry pick the best transactions (b) Take proactive measures to de-risk your project such as obtaining presales (even if not required by your lender) (c) Allow for additional project contingencies, more so than you may have in the past (d) Engage with your consultants, builder and funder as early as possible (e) 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.

The next 12-24 months will be challenging; business models will have to evolve and innovative thinking will be required from investors and developers.

Parash Sarma is Client Services Director at ASAP Property Finance Specialists based in Auckland.
Phone 021-864730; Email: parash@asapfinance.co.nz