Reserve Bank warns investors' to be wary of risks around private equity-based property developers

By Gareth Vaughan

The Reserve Bank is warning potential investors' to be wary of private equity groups looking to raise money to invest in the bombed out property development sector.

In its November 2010 Financial Stability Report out yesterday, the Reserve Bank notes that finance companies exposure to the property development sector is likely to remain greatly reduced given the retail debenture funding model for such high risk exposures has been proven to be “unsustainable.”

An array of property financiers have collapsed over the past three years including high profile casualties such as Hanover Finance, Strategic Finance, St Laurence, Capital + Merchant, Lombard Finance, Belgrave Finance and Dominion Finance. None are expected to return more than one third of their investors’ money. 

The central bank points out that banks have also demonstrated a reduced appetite for property development lending and says the funding of viable property development projects is likely to require new funding models better suited to the financing of higher risk projects.

“For example, a number of private equity-based funding vehicles have been launched over recent months with the intention of financing both new and existing property development projects," the Reserve Bank says.

“It is important that potential investors in proposed investments are aware of the nature of the risks to which they are exposing themselves and undertake adequate due diligence when making investment decisions.”

A Reserve Bank spokeswoman declined to name any of the private equity vehicles the central bank was referring to.

Second mortgages, capitalising interest

In the case of the finance company property financiers, many had second mortgage positions over property developments putting them behind other financiers such as banks in the queue for repayment when projects went bust. And many of their loans were made on a capitalised interest basis, meaning interest accruing was added to the loan balance and received on repayment of the loan, rather than being paid on a monthly or quarterly basis.

Strategic Finance’s receivers recently highlighted just how tough things remain in the property development sector telling thousands of secured debenture holders they might get back as little as 12%, or NZ$44.1 million, of their NZ$367.8 million worth of principal investment.

The receivers, John Fisk and Colin McCloy of PricewaterhouseCoopers, say they’ve given up trying to sell Strategic’s loan book and will instead aim to realise individual loans themselves. Of Strategic's 87 loans, the receivers say about 25 of the borrowers are now either in liquidation, receivership or the property owned by the borrower is in the process of, or has been, sold by the first mortgagee exercising its power of sale.

"The property market continues to be challenging and volatile, particularly in respect of development land and bare land subdivisions,” Fisk and McCloy say. “Borrowers continue to face difficulties in achieving sales or refinancing of the property."

Meanwhile, managers of property syndicates say investor interest in their schemes, which the Securites Commission has issued a warning on, is growing.