Mitigating Lending Risk Based on Property
Property is a great investment because, statistically speaking, it will double in value over a decade. How do the big lenders work toward mitigating lending risk based on property?
In cities like Melbourne, Sydney and the up-and-comers like Brisbane, Perth and Darwin, one could almost assume that generating revenue from your investments is a sure thing.
But, what of the initial investment required to purchase a property? If you’re a first time buyer, many are opting to purchase properties, or even land in estates and developments that are 30+ minutes in travel time from a CBD.
Melbourne in particular, not geographically hamstrung by the winding eddies and waterways of a city like Sydney, is experiencing significant growth in its northern areas.
“Buy where you want to invest, rent where you want to live” is a viable strategy that many first home owners are opting for, purely because the majority of “local” houses fetch in excess of half a million dollars at auction.
That’s for a “fixer-upper”
Take it back a step, when you’re seeking a loan from an institution so you can buy that first home, what sort of criteria are the lenders looking for over and above your Veda profile?
A sketchy credit history will cause you some headaches if you’re trying to secure a loan, as will a shady tax history, even self-employment – solo-preneurs in particular – cause the proverbial magnifying glass to come out over the application.
But does the property itself have any bearing on whether the bank will loosen their money belts for you?
The answer, perhaps counter-intuitively, is yes.
Banks lend on the basis that if things don’t go so well for you, and if, at some point in the 30-year period you actually cannot pay off said loan, the bank wants to foreclose, and flip the property to get its money back.
Certain attributes will cause a lender to “look twice” at an application based on the property itself and not the financial standings of the applicant (this is of course another consideration)
Here are some pointers worth considering before you go for a loan.
Whilst this is not an exact science, there are people in the know within the property industry who feel that 40-50 square metres is the cut-off point for many lenders.
Simply because such a small apartment might not have the capacity to deliver a return if things turn sour for the individual who is unable to pay their mortgage.
Ultimately the final decision on whether a bank will loan out its money comes down to whether they can make that money back, and smaller apartments, oddly enough, are seen as a risk to deliver on a return.
This places some studio apartments, lofts and student accommodation in a “risk” category for some lenders.
This is a case-by-case assessment. A studio apartment in one of Melbourne’s burgeoning café laden, back alley gems will always fetch a good price since they are always going to be in finite supply, and there will always be a demand to live in Melbourne’s CBD.
The Victorian state government’s decision not to impose restrictions on the minimum size of a domicile has not whetted the banks appetites, and many are adamant that 40 square metres is the limit.
Regarding student accommodation, there is an inherent volatility there since government policies on student migration can change with each new term for a new government. This represents a risk for the banks because they might not be able to move the apartments based on government sanctions.
Serviced apartments are often leased through a third-party business operator that the banks dislike because of the lack of control it gives them. Some of these apartments, that come pre-furnished, if in a good location to a major city, represent a lucrative Air B’N’B opportunity for owners, but this does little to mitigate the risk a lender is willing to take.
This is not a stretch to understand even for someone who has no idea about investment. Affluent areas tend to have less “risk” or the potential for less “problems in the neighbourhood” than a poorer area.
You’d expect more unsavoury types to be hanging around the projects in Brooklyn than in Manhattan.
Affluence by its nature mitigates this risk because people who have a means to earn money by their employment are less likely to turn to illegal means to turn a buck.
Poorer areas that may have a drug problem, or gang crime, or even a sense of unease about it, will have properties within its borders that is harder to sell than a safer neighbourhood.
Should the owner default on their loan, the lender will have a harder time selling the property and recouping its money since the appeal to live in an unsafe area is not something people generally leap at the chance to do.
In Australia, the mining boom of the last 15 years or so has caused shanty towns to spring up like desert oasis.’ These living quarters for miners who operate on the FIFO (Fly-In-Fly-Out) employment model will be ghost town once the mines dry up. This is a big risk for lenders.
Perhaps the most interesting of criteria for a lender not wishing to open its purse-strings is growth areas. Suburbs where the skyline is dominated by cranes can be seen as being less appealing to people.
This is not due to the vista itself, rather it is to do with over-saturation. Should the property market take a down-turn in the future, densely populated vertical areas – like the Southbank area in Melbourne for example, will experience a glut of apartments, but the demand will not be there.
The property experts flagged stratum titles, company share titles and tenants in commons titles as presenting a risk to lenders, because they may take longer to sell later.
Properties with structural issues represent an obvious problem because of their potential to cause injury, through failing brickwork or rotting materials (as an example) and their potential to damage the hip-pocket of investors that have to re-borrow to fix structural problems.
Aside from the odd termite problem, there are building codes to adhere to that can represent a really large risk for the lenders in the event the property doesn’t comply and the investor runs out of money.
Similar to structural issues, properties build on unstable land – such as a marsh or quagmire – have a greater risk of being rendered inhabitable until said issues are resolved.
This could mean reinforcing the property with stumps, or something more extreme.
The costs to do this can be significant and has the potential to send an investor bankrupt. Lenders are then faced with a property that is not only difficult to sell, but is largely unsafe too.
Coastal properties are susceptible to violent storms, wind and erosion from the salty air.
As the Earth’s climate becomes more and more unpredictable, these sort of factors are being considered more and more heavily by lenders.