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Property - Who wants to be a Bankruptaire

  1. Nasty surprises hidden in apartment investing - particularly deposit bonds and on-selling off-the-plan units. Did you know you are still liable if the person you sold to defaults ?

    I think that in Vic at least disclosure of rebates is legislated. Not sure of other States....

    This from todays Fin Review

    Property profiteers
    Oct 26
    Gerry van Wyngen


    The real estate industry is serviced, on the whole, by hard-working, honest men and women. But the boom has brought in a number of grossly immoral practices that are tolerated as part of business, and a number of operators whose practices border on the criminal. Both have been contributing factors in ramping property prices to today's exorbitant levels, and will contribute to the pain of the fallout.

    The range and depth of such abuses has not been seen in the Australian investment industry since the 1969 Poseidon share boom and bust. That led to a government inquiry and eventually legislation and supervision for the securities industry.

    A generation later, this time in the real estate industry, we have reached the same point.

    It is, perhaps, a point that has escaped government.

    The residential property industry has increasingly marketed itself as an investment industry. "Your home will likely be your largest/best investment", or words to that effect; "buy an investment apartment", or "comparing home property with other investments..."

    Not only has the real estate industry become part of the investment industry, by name and by deed, but it is the single largest sector within it. Yet, in complete contrast to other investments, practice and conduct are very loosely regulated.

    As a result, Australia's residential property market boom is being threatened by its own excesses. The main problem stems from the unregulated promoters of investment property, such as apartments. Many hopefuls have entered agreements and contracts in good faith with such promoters, only to find that these structured arrangements are in fact high-risk investments.

    A number of practices that are tolerated at the moment may turn out to have been illegal. If this is the case, some contracts may be challenged. Some of the conduct accepted in the industry would certainly be illegal if it occurred in other sectors that have more customer protection, such as financial services. That raises the question why real estate investors are not entitled to the same protection as those who invest in money market deposits, debt instruments or shares.

    Legislation appears to be grossly inadequate. Section 12DC of the Australian Securities and Investments Commission Act 2001 forbids false representations and other misleading or deceptive conduct in relation to securities that involve land, in respect of a corporation. By implication, land that is not traded in the form of securities, as is the normal case when purchasing a house or an apartment, appears unprotected under the act. Similarly, if the legal entity making the representation is not a corporation, then apparently it is not covered.

    A call by the Weekend AFR to ASIC to clarify this was not returned.

    Just this week, the Victorian Government introduced into Parliament proposed changes to the Estate Agents Act and the Sale of Land Act. The changes include prohibiting dummy bidding, and prohibiting real estate agents from pocketing any rebates, discounts or commissions received in respect of promotions rather than passing them on to the paying customer.

    An indignant Melbourne real estate agent complained to his colleagues that this "is treating agents like criminals". Exactly.

    Rigging markets and secret commissions are criminal offences when dealing in securities markets, and have been for decades. Extending this to real estate is long overdue. Not only in Victoria, but in every state.

    Sales or referral commissions beyond those paid to licensed real estate agents are rife. Many of these are reportedly paid to "investment advisers", although what proportion of the "advisers" are advisers licensed by ASIC is an interesting question.

    Often the "investment adviser" is paid a commission of "only" 5per cent. However, especially in Melbourne, there are reports of commissions as high as 10 per cent. You might well wonder how independent the advice of an adviser receiving a 10 per cent kickback might be.

    In the securities industry, a commission of more than 0.5 per cent is often regarded as excessive inducement. More than 1 per cent is definitely over the top.

    Many of the commissions paid to unlicensed agents are undeclared; some buyers are unaware that any commission is paid to their adviser, let alone the amount or percentage. Not surprisingly, there is a common interest in hyping up the value of the property.

    This is not to suggest that all vendors or their agents condone such practices, or indeed advisers. However, where a vendor declines to pay a fee, there are reports of advisers adding their fee on top of the retail selling price, and the buyer not being aware of this.

    The conflicts of interest escalate with the investment seminar vendors. People turn up for seminars expecting to receive objective investment advice, but often what they get is a lecture on how to secure an investment apartment in a project favoured by the company holding the seminar.

    At least one group has reportedly charged commissions as high as 100 per cent for securing deposit bonds costing only $2,000 on properties controlled by it or related parties.

    One seminar group is known to have purchased blocks of 100 apartments or more and on-sold these to seminar "students" at mark-ups allegedly ranging from $30,000 to $90,000.

    That practice has further consequences. Many buyers of investment apartments believe, and in some cases are told explicitly, that these may be financed at settlement on 90 per cent finance.

    Where the price of the property has been inflated, clearly the lender's valuation may be lower than the purchase price, meaning that 90 per cent of valuation finance will be insufficient to secure the property.

    But the buyer is committed. They have a legal contract to settle.

    And that is the time bomb in the industry. Much of the off-the-plan buying has been of apartments that will not be completed for 12, 24 or even 36 months. Usually the apartment is bought on a 5 per cent or 10 per cent deposit, or a deposit bond for that amount, with the balance to be paid upon completion. Often, especially for commitments 24 or 36 months away, finance is not arranged until settlement time approaches.

    For buyers whose "investment strategy" was to on-sell the apartment at a huge profit before settlement, that seemed logical. But what if the apartment is not on-sold and the market starts to turn down? A valuation by the bank lower than the purchase price will require the buyer to invest further equity, which in some cases the buyer may not be able to provide.

    Concurrently, lenders could tighten their lending criteria, perhaps lending a maximum of 80 per cent or 85 per cent valuation. This may put an extra cash squeeze on the buyer. An obvious solution would be to try to sell the apartment, but there may be other buyers-turned-sellers, and they would be in further competition with other buildings still being sold off the plan.

    What makes this a likely scenario is that marvellous innovation in property financing, the deposit bond. This is a surety or guarantee for an agreed deposit amount to be paid by the underwriter at settlement of a property. The purchaser in turn indemnifies the underwriter.

    For a deferred purchase, such as an off-the-plan apartment, nothing could be more logical. Why have, say, $20,000 or $30,000 locked up for 36 months awaiting settlement? A deposit bond will do the same job as a deposit, for a reasonable fee.

    The deposit bond market today is maturing, with two brokers (United and Deposit Bond Australia) dominating, and three main underwriters (Royal & SunAlliance, GE Mortgage Insurance and QBE Insurance Group).

    It wasn't always like that. There were more players, not all of them stayers, and some loose practices until about six months ago.

    Bonds were often provided easily and without sufficient checking. As a consequence, some buyers who might not be able to settle a purchase were given bonds, and some were given a number of bonds, sometimes through different brokers without one knowing about the other. What will happen at settlement time, and what effect it will have on the market, remains to be seen.

    It gets worse. Until April this year, quite a number of "purchases" were through put and call options, a mechanism used to defer registration and payment of stamp duty. Some of these were later "on-sold", by way of assignment. The vendors in most cases are probably blissfully unaware that they are still legally liable if the second "purchaser" does not perform.

    Off-the-plan purchases that are on-sold before settlement have a similar liability. If the second purchaser does not front up at settlement, the original purchaser has to perform. How many know that?

    Will the litany of abuses by marginal players, and inadequate protection for buyers, have to end in tears, as the Poseidon boom did, before the authorities act?

    There is no reason why government cannot announce right now that legislation will be drafted and introduced along the lines of the original securities industry legislation, and that it will be effective from the time of the announcement.

    The announcement should state specifically that the new act will cover all types of real estate sold to non-professional buyers; prohibit making false markets; confer obligations not only on corporations but also on institutes, foundations and individuals; impose requirements and obligations on "investment advisers"; require written declarations of interests including principal or agent and fees or commissions receivable; require written explanations of contract obligations in simple language.

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