Where Will Property Developers Obtain Capital From?

The news that the directors of Lombard Finance received from the Court of Appeal home detention sentences substituted for the community work and reparation sentences they received in the High Court was greeted with much whinging about finance companies in general.

But with the collapse of the finance company sector, and of lending to risky property development projects in general, where will property developers obtain capital from? It sure won’t come from the big banks and it is ridiculous to expect NZ private investors to organise funding schemes organically.

In his weekly overviews, Tony Alexander has pointed out that some developers are raising finance in China for projects in Auckland. This is an interesting development, particularly when it is harder for regulators to keep track of overseas promotion of New Zealand investment schemes than if they stick to our shores.

While foreign capital is obviously essential to any supply side response to a housing shortage in Auckland, we cannot ignore the role that altered bank preferences because of Basel III have on the risk takers in property development.

Many property developers have left the industry with their tail between their legs because their last big project – which funnily enough would generally have contributed somewhat to an increased supply of housing in Auckland – failed at the peak of the global financial crisis for reasons more to do with banks reducing their risk profile as opposed to holding out for the rebound that has occurred since.

Finance companies filled an important role by taking on a lot of high risk projects that banks could easily finance – except for the fact that a new property development, because of past oversight mistakes and wet behind the ears lending managers, is unlikely to pass a credit risk committee with new capital and liquidity requirements imposed by fiat around the globe.

I disagree with Shamubeel Eaqub that we can’t build far more houses than we currently do. Much of the blame for the “shortage” of skilled construction labour is that those who used to employ them had the plug pulled by risk averse bankers right when continued work through the global financial crisis would have seen an additional 50,000 or more housing units constructed from 2008 to 2013.

Developers with strong balance sheets (read: a handful) will be able to complete projects and will earn reasonable margins if they can avoid delays and lock in labour on medium term contracts.

They are ably assisted in their profit maximisation by the demise of the second tier lending sector because their traditional competition – those oft criticised property developers – have more chance of an Official Assignee court case than a resource consent hearing on a new subdivision.

There is a market opportunity, already realised by the Manson family of Auckland¬†with their New Zealand Mortgage & Securities, for mezzanine finance in New Zealand that is more in tune with the reality of construction sector projects. It’s risky business – but it’s risk taking that will drive the economic recovery and lead construction back to where it needs to be to match domestic migration to Auckland and population growth in general.

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