No romance without finance – how do recent changes to investor finance change the game?

In a concerted effort to cool the market, the RBA’s jaw-boning was complemented in April with significant action from the Australian Prudential Authority (APRA) to clamp down on lending practices to the investor market.

Regardless of how the impact of these changes impact the market, all investors need to understand how the changes will affect them.

We thought we would ask two leading finance brokers for their insights into what the changes are and what the implications for investor and development finance in the short term.

  • Michelle Coleman (MC) is the founder of W Financial. Michelle has achieved over $500M of settlements in her 12+ year career to date, and won numerous industry awards, including #3 MPA Top Broker.
  • Renato Sturma (RS) is a partner of Finance Advocates a specialist property development finance consultancy with 30 years experience and over $1 billion of loans funded.

P+P: What are the key changes that have been implemented?

RS – The two main changes that have occurred are the lowering of the lending ratio’s to 80% for investment properties and the removal of interest rate discounting in some instances.

MC – The key changes that are coming in to play are different based on each lender’s portfolio and their reaction to the tightening of investment lending. These changes have arisen due to APRA (Australian Prudential Authority) communicating to all lenders that it will be reinforcing sound mortgage lending practices, in particular with investment lending.

The key areas that they are focusing are;

  1. higher risk mortgage lending — for example, high loan-to-income loans, high loan-to-valuation (LVR) loans, interest-only loans to owner occupiers, and loans with very long terms;
  2. strong growth in lending to property investors —since its been well over 10% they are looking at ways to reduce the rate of growth in this sector as they see it as risky to the housing industry
  3. loan affordability tests for new borrowers — in APRA’s view, these should incorporate an interest rate buffer of at least 2 per cent above the loan product rate, and a floor lending rate of at least 7 per cent
  4. So depending on each lenders loan book and the mix of investment lending – each have released varying changes for investment loans.

These range from;

  • Reducing the total LVR available for investors e.g. from 95% to 80% across the board or in only some states
  • Removing the pricing discretion above the advertised rates for investment loans (unless you are an existing client)
  • Changing the way that loans are assessed for servicing in regards to investment loans with further benchmarks & buffers.
  • Small increase for investment loans interest rates.
  • And some have also removed the option of interest only for owner occupied loans.

P+P: Do you think will there be more changes to come?

RS – I think we will need some time to digest what impact if any these changes will have before there are any decisions made on further changes and what they might actually be.

MC – There have been constant changes even up to now as I am writing this as each lender has assessed their position. I believe that all lenders will have to make some sort of change but there will be differing levels of changes. There are only a few that haven’t made any adjustments as yet.

The feedback that I have been getting from lenders is that depending on the fall out there may be more changes but it feels like many are just waiting to see what will happen. All market reports are indicating there has been no slowdown of investor’s growth but I think any kind of impact does have a time lag to come through. I have had many clients concerned with the changes & holding off taking action but my personal opinion is that the investment strategy that we speak about with clients is even more important now, particularly around making sure you have built in buffers.

I also believe over time that these rules will be relaxed again and there will be changes back again to remove or soften the recent hardening of assessment & pricing for investor loans.

Keep in mind the interest rates are the lowest they have ever been & this means you can borrow more as the assessment rates are lower too. It’s smart to keep this assessment rate at a 7% rate as this is the long term interest rate average.

P+P: Have all lenders been affected (is there an impact for Credit Co-op’s, Building Unions and alternate non-bank sources of finance)?

RS – At this stage I have only seen official notifications from the banks I deal with but I would imagine that this would apply across the board in most cases.

MC – Yes all lenders are covered by APRA and will be under their scrutiny & will need to make amendments to the way that they deal with investment loan applications & assessment. It will come down to their mix of owner occupied vs investment in their loan book.

P+P: Are the old deals (I.e. LVRs and discount rates) still available from some lenders?

RS – We have been advised by a number of banks that if your owner occupied loan is not with that bank that the old deals won’t apply.

MC – Effectively there was only one lender in the market place that was approving loans to investors at 95% plus LMI before the changes. They of course have changed to 80% LVR but my opinion is they have done this because of their exposure to their current book and not to new lending. There are many banks that will lend to 90% – but there have been many that have changed this to include LMI and not allow LMI to be capitalised.

P+P: Has development funding been impacted? If so what have these changes been?

RS – Development funding hasn’t really been impacted as their LVR lending ratios were already pretty much at these levels anyway

MC – I have not seen this filter through to commercial development funding. I would guess that this is because the assessment of the loan is based on the project mainly & is a shorter term loan in comparison

P+P: Do you think these changes will have much change on the market?

RS – It’s difficult to say but based on the short time the new changes have been in place it doesn’t seem to have had too much impact on the auction clearance rates.

MC – I don’t think there will be a massive impact on the property market. There may be a slowdown in the investor sector but I think the smart investors will just adapt & continue to invest but will have to use a good broker to navigate way through the different lenders appetite for investors.

P+P: What’s your advice to investor/developers?

RS – The developer that purchases a property with the view of working their way through a planning permit needs to be aware that they may have an equity requirement of 20% now instead of the option of borrowing up to the higher levels

MC – Proceed as normal – stick to your strategy.

Only reassess your options if your borrowing is reduced with the tougher assessments.

You could either purchase in a different area with a lower price range or consider creative strategies to improve the position. Eg income partners or private money partners.

Most smart investors would have had their own buffers in place when assessing their own situation so the tougher criteria shouldn’t affect them too much. Just because rates are low now doesn’t mean you shouldn’t plan for a higher rate environment as they will eventually go up.

Don’t wait to get your funding organised to see what happens. I would always suggest to always borrow when you don’t need it. As many know life can present certain challenges & normally when you need it is when lenders won’t lend it to you. You want to get this all set up just in case there are further changes. Remember you don’t pay interest until you use the funds.

Don’t panic – keep in mind that the rates are the lowest they have ever been & you were able to borrow the most so putting some protection around that isnt a bad thing. Paying a little more on the interest rate isn’t bad either, the main thing is to keep investing

P+P: Is there anything else investor/developers should be mindful of?

RS – Whilst the climate looks like rates will stay low for a while investors / developers should make some allowance for the potential for rates to go up at some stage and having the ability to service that debt comfortably should that occur.

As we have all experienced permits can be delayed for numerous reasons and if one is in a holding pattern waiting for this to occur, you need to be positioned to be able to service your debt for the extended period with a buffer as well.

MC – Assessment of loan applications will become harder & more questions will arise from credit departments. Just bear in mind to be organised & respond as requested. You have to remember that you are borrowing hundreds of thousands of dollars and if you were in that position you would be asking questions to confirm your risk also. Mortgage brokers are on your team & will be requesting documents to get you the best result and aren’t doing it just because.

Rates will be higher – but only marginally. Is this really that important? You never pick a lender based solely on rate just like you shouldn’t choose a property or particular strategy just for the tax benefits.

P+P: What’s the best way to fund one’s property development?

RS – First engage quality professionals such as Pillar+Post and Finance Advocates Australia to make sure you do the right due diligence and get the right assistance with your finance.

An expert team can then guide you through as issues that arise.

The cheapest path will always be the banks but that comes with certain hurdles / milestones to meet. Second tier options can then be looked at if that’s required.

MC – The best way to fund one’s property development hasn’t changed.

There is a 3 step process that fundamentally will not change:

  1. Site Purchase – many clients do this as a normal residential loan if the property is habitable & of course residential. Up to a max LVR of 90%
  2. Construction/Development Loan – this is the construction funding and depending on LVR and how many units you are planning it could be residential or commercial construction. Development funding is normally up to 80% of Total Development Costs or 65% of Gross Realised Value whatever is the lesser
  3. Take out finance for the retained stock. This can be with the one developer or transferring each unit to the syndicate member.

Only proceed to fund the property development when you have mitigated as much risk as possible which would include establishing your max limit. You need to ensure you aren’t overcommitting your income or your capital and not leaving buffers.

There other ways to mitigate this risk which would be either one or a combination of;

  1. Don’t proceed with the funding unless you have debt coverage from your pre-sales. This can be either to the open market or within a syndicate
  2. Consider going a higher LVR- even with a slightly higher rate leaving more of your capital in reserve
  3. Do the project with others in a syndicate – spread the risk (there are a few groups that can help with this like Property Collectives)