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AFR: Distressed $1 million-plus property sales a 'warning' to mortgage holders

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Oversupply in Melbourne?

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The distressed sale of a $2.5 million luxury townhouse with sweeping views of Melbourne's bay and skyline should be a wake-up call for financially-stressed property buyers, say estate agents.

Realtor Andrew Fawell has valued four distressed – or mortgagee –  sales in the past two weeks for houses and apartments valued between $1 million and $2.5 million located around Melbourne's coveted, prestigious and expensive inner south-east fringe.

"The drum is starting to beat," says Fawell about home buyers and investors who might be feeling pressure from rising repayments, static incomes and stagnant rents.

"I expect to be doing it a lot more often over coming months," he says. "But lots of property buyers and investors are in denial about their precarious situation."

Strong economic growth, high employment,  growing immigration and record low interest rates continue to bolster the nation's property markets, despite sales volumes and prices retreating from recent highs. Housing loss rates for the major banks are running at just two to three basis points, according to analysis by investment bank Morgan Stanley.

But for the first time since 2012 when the global financial crisis hit local property markets – four years after it rocked Wall Street – valuers are being routinely asked by lenders to do kerbside assessments of what properties might sell for at a mortgagee's auction.  

"This is not happening on 'Struggle Street'," says Fawell, whose Beller Real Estate buys and sell properties in many of Melbourne's most coveted suburbs within a 10 kilometre radius of the central business district. "These are expensive properties in top suburbs that are being put under the liquidator's hammer."

The four-bedroom townhouse on Melbourne's exclusive Marine Parade, valued between $2.5 million and $2.7 million, is being sold in a mortgagee auction early next month.

The Elwood property, which includes a designer self-contained apartment, features two balconies and panoramic views of Melbourne's CBD and the bay.

Lenders liquidating a property typically avoid the term "mortgagee sale" because they fear it will attract sassy bargain hunters  looking to lowball  their bids because they  know the property has to be sold. 

Problem with fixed loans
Houses and apartments purchased for millions of dollars are being put under the hammer because  owners can no longer afford their mortgage payments, particularly when they have to start paying principal at the end of a lower-cost interest-only term. 

Analysts warn some property owners and investors are under growing pressure because of static (or falling) prices and higher costs – particularly borrowers whose three- and five-year interest-only mortgage terms are due to be reset as principal-and-interest loans. 

About five years ago  big lenders started flogging interest-only mortgages like hotcakes with waived fees and lower interest payments during the term. The big banks' loan book exposure to interest-only loans ranges from about 45 per cent for Westpac to about 30 per cent for ANZ.

For interest-only borrowers, the principal is not reduced over the term. 

At the end of the interest-only period, borrowers revert to principal-and-interest repayments, which means they are paying interest as well as repaying capital over the remaining loan term.

At this stage borrowers must show they can meet minimum serviceability levels equivalent to an interest rate of 2.25 per cent above what they are currently required to pay, or 7.25 per cent. Usually the lower percentage applies.

Analysts estimate that thousands of homeowners face a financial crunch as $60 billion of interest-only loans written at the height of the property boom are reset at higher rates and terms over the next four years.

Extra hoops to jump through
For example, a typical borrower paying 4.5 per cent on a $400,000 loan will have to prove to  the lender that they can meet repayments for a 7.25 per cent loan – in other words, that they have capacity to make annual repayments of nearly $33,000 from $18,000 currently.

It's potentially worse for many self-managed superannuation fund (SMSF) investors who bought investment properties and  are prevented from making bigger payments because of annual caps on the size of their super contributions.

The annual super contribution cap is $25,000, which includes compulsory super, and loans have to be funded from within the SMSF. 

Steve Lusi, director of Direct Property Group, says: "Property buyers need to be planning ahead for the end of their interest-only period. They can't start preparing too early. That's for both the higher serviceability and more costly monthly payments."

It is also worth acting now in order to pay down principal when interest rates are low, he says

Andrew Peters, general manager of financial adviser Semaphore Private, adds: "Well before the term expires, start reviewing all expenses and income. Beware of taking on any new leases, buying new cars or other avoidable luxuries." 

Alternatively, a cash-strapped owner might consider renegotiating another interest-only term.

This strategy might suit sophisticated investors requiring repayment flexibility because of business cash flow issues, those wanting to keep their funds on standby in an offset account for emergencies, or investors planning to invest any excess funds in other assets.

Exit strategies
A rule of thumb is that a five-year interest-only period will cost about 11 per cent more in interest over a 30-year term, according to financial advisers.

There is also the risk that refinancing to the cheapest interest-only loan is a short-term solution because rates are routinely being increased by lenders under pressure from regulators to contain consumer debt.  

Fawell says investors in trouble need to get an accurate estimate of their property's value and decide whether to sell, particularly a poorly-performing investment property not delivering income and capital growth.

"Portfolio investors might offload an apartment. Some might be good performers so it's an opportunity to cull the weak," Fawell adds.

Don't walk away from a property that a lender wants sold because they are only concerned about covering their debt, principal and outstanding costs, which means they might not push for the best deal for the seller, he says

 

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Top end tends to be more illiquid because of the shallower market of potential buyers.

That must be a pretty swanky apartment for 2.5m. Most around the 1m mark are glorified dog boxes.

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