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01 July 2003

Falling Dominoes

BE WARNED – They are heading your way.

The long expected property disaster is looming larger than ever. The front page story in today’s Australian may seem sensational, but if it’s half true, it will be a disaster with huge consequences.

And remember, the authors of this story, Robert Gottliebsen, Geoff Elliott and Elizabeth Colman, are widely respected commentators. This is not a sensationalist media beat up, it is a story with an ominous ring of truth.

According to The Australian, Melbourne and Sydney are about to face the “biggest residential crisis in a decade”. It’s all about those off-the-plan sales that are due for settlement next year.

Today’s report says that thousands of investors will be unable to complete their purchases. Of course, many of these investors had no intentions of ever completing the sale. It was their intention, in a rising market, to on-sell their apartments and walk away with a tidy profit.

Expecting to ride the ever increasing wave of rising prices, investors paid ten per cent deposit on apartments that were not built. All they saw was an architect’s plan.

Back in 2001, with prices rising daily, it was easy for salespeople to convince buyers that by the time the apartment was built it would be worth a lot more. And, according to the common sales spiel, the best way to make money in property is to use what’s called “leverage”. If you pay ten per cent deposit and the price of the property goes up by ten per cent, you have doubled your money. It sounds great – in theory.

However, just as leverage is a triumph when prices are climbing it is a disaster when prices are falling. If an apartment is bought off-the-plan for $400,000 and then, when it is completed, its value turns out to be $360,000, the buyers are in real trouble. Especially if the banks tighten their lending criteria.

And that’s exactly what’s happening now. Two years ago, property prices were going up by 15 or 20 per cent a year –and banks were falling over themselves to lend up to 90 per cent of the purchase price. It seemed like a no-lose deal.

But how things change.

Today, many of the apartments that were sold off-the-plan for say $400,000 are now worth, at best, $360,000. And, instead of the banks being prepared to lend 90 per cent of the value (not the purchase price), many have now reduced the percentage of the value upon which they will lend. Some banks will only lend 50 per cent of the value of city apartments.

If the buyers paid $400,000 and the completed apartment is now worth $360,000, the maximum loan available will be $180,000. Gulp. Time to go looking for a new lender.

Suddenly, instead of pocketing a profit of at least $40,000 (had the apartment increased by ten per cent to $440,000) the buyers now have to reach into their pockets and find anything up to $220,000.

Many buyers will throw up their hands and walk away. They will lose their deposits.

But it gets worse.

The developers will then sell the apartments for the best price they can get and chase the investors for any losses. For example, if the apartment sells for $300,000, the investor will lose $100,000 ($400,000 less $300,000).

Many investors will be faced with two choices – sell at a loss or borrow against other assets in order to complete the sale. Some investors – especially those whose assets are not solid – face a far more ugly prospect. They will have to sell their family homes to cover the shortfalls.

This is why today’s report is so frightening. It is no exaggeration to say that the apartment crisis will lead to “much wider ramifications including a further fall in the overall real estate market.”

Those commentators who say that real estate markets differ from area to area have failed to see an obvious point in the real estate world. All markets are linked.

A crisis in one segment of the market is a sign to what will eventually happen in other segments of the market. It happens when prices go up and it happens when prices go down. It’s like a domino effect. When one starts to fall, it causes another to fall and so on. Finally, it leads to all the dominoes falling.

The warnings have been clear for at least two years – real estate prices have risen too far. They will fall. For most investors who bought off-the-plan, it is too late to escape unscathed.

For those in other areas, here’s some advice.

Check your financial position. The falling dominoes are heading your way. If you can sell now for a good price – even a profit – it might be worth considering selling.

After all, you never go broke making a profit.


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