The house and land value trap

By Leith van Onselen

Last month, I wrote an article in MacroInvestor entitled Beware the house and land value trap, which examined the pitfalls of buying new house and land packages on the fringes of Australia’s capital cities.

The article was particularly critical of measures adopted by Australia’s property developers aimed at reinvigorating new home sales by offering generous incentives to new buyers, such as giving away new cars, offering large cash-backs, free landscaping, or paying a buyer’s energy bills for three years when they buy a new house and land package (see below examples).

By offering such giveaways, developers are effectively offering buyers of house and land packages big discounts without reducing the face value of house and land contracts.

However, such incentives are also precluding the new home market from functioning properly.

A buyer of land that comes with an incentive, such as a new car, pays stamp duty on the higher contract price, resulting in more stamp duty being payable than if the price had been lowered by the amount of the incentive. Moreover, when the buyer seeks finance, the bank is more likely to value the property at a lower level than the contracted price, thereby reducing the amount that the bank will lend and effectively increasing the borrower’s required deposit.

Indeed, earlier this year it was reported that bank valuations on new house and land packages were coming in -15% below developers’ sale price valuations, meaning that new home buyers were being forced to contribute 15% more funds (on top of any housing deposit) in order to cover the valuation shortfall, or forfeit the sale.

With new home sales continuing to struggle, there are now growing calls for the industry to abandon incentives in favour of transparent land price deductions. From Chris Vedelago at the Age:

DEVELOPERS are being urged to end discounts and giveaways for new home purchases as concerns mount that the incentives are distorting the market and making it tougher for first home buyers to get financing.

The call comes as research shows the typical block of land now includes nearly $13,000 worth of developer incentives, pushing the median price below $200,000 for the first time since the first home grant-fuelled boom of 2010.

But some industry players warn that what began as a temporary measure to boost demand during the property slump is causing a growing number of buyers problems as valuations fail to stack up.

”The rebating has caused an enormous amount of confusion for buyers and valuers about what the purchase price of the land is exactly – does it include or exclude the rebate?” said Sam Tamblyn, managing director of valuation firm Urban Property Australia.

”Valuers are taking it to be the net price [without the rebate]. That’s causing problems for purchasers with their loan-to-value ratios and deals are falling over.”

With financial institutions reportedly reluctant to lend on the face value of the contracts, first home buyers are being forced to provide additional equity to cover the discount. Those who can’t make up the difference are defaulting on the contracts…

Australand general manager Rob Pradolin said incentives had become so pervasive it was time developers recognised that prices had effectively come down and adjusted accordingly.

”I’m calling on the industry to recognise where prices are, set them at that level without incentives and start selling value again,” he said.

”It means customers will pay less stamp duty – making it even more affordable – and there’ll be no surprises when buyers go to the bank.”

Australia’s property development industry appears to be caught in a pincer. If they don’t abandon incentives in favour of transparent land price deductions, financing of new house and land packages will remain problematic and sales will likely continue to struggle. At the same time, reducing the listed price by the same value as the bonuses and incentives being offered could lower their collateral value, potentially triggering the banks to call in more equity from bank-financed developers to bring their loans back to agreed conditions and/or loan terms. Straight price cuts are also more likely to aggrieve recent purchasers that paid higher prices.

Ultimately, the core problem with the new house and land market in Australia is that prices remain above what many buyers can afford or are willing to pay. And until prices deflate, the rate of home sales and construction activity is unlikely to rebound materially, leaving Australia’s property developers holding large land banks that they cannot offload.

Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.