21/07/2008
As the global credit crunch continues and suburban property values fall right around the country, mortgagee repossessions are on the rise. Are these properties really a goldmine for investors or is that just a myth? James Evans investigates
In April 2002, the major banks’ standard variable interest rates stood at 6.07%, their lowest level in over 30 years. Property prices were going up and it seemed that everyone was making money out of their real estate investments.
Fast forward six years, and bounding inflation and the global credit squeeze have pushed the average standard variable rate to 9.39%. Property prices are slipping, especially in outer suburban areas of capital cities. In some cases, more money is owed on a property than it’s worth – the dreaded ‘negative equity’.
For an increasing number of homeowners and investors, the burden has become too great. They are being evicted from their homes or walking away from their mortgages, leaving lenders with assets that they don’t want to maintain.
When the mortgagee steps in
Missing a couple of mortgage repayments doesn’t immediately trigger repossession. For both banks and non-banks, there are certain steps that must be taken before a writ for possession can be served.
“Typically, for a bank, the process for recovery of a defaulting borrower’s property will take at least six months and in many cases much longer,” says David Bell, chief executive of the Australian Bankers’ Association (ABA). “For all lenders there are a series of notices requirements that need to be made. After the expiry of these notices, if possession of the mortgaged property is required, the mortgagee must issue and serve a writ for possession on the debtor and obtain judgment for possession.”
Gavin Hulcombe, director of the Brisbane office of property advisory group Herron Todd White, confirms that lenders don’t require hasty valuations of their mortgagee-in-possession properties. “Probably to the contrary,” he says. “With our standard mortgage security valuations, we work on a turnaround of two to three days. Where it’s mortgagee-in-possession, it goes through a fairly lengthy process before we actually do the valuation. There’s no undue pressure.”
A growing phenomenon
The Reserve Bank of Australia’s (RBA) September 2007 Financial Stability Review examined the question of mortgagee repossessions. In that report, the RBA noted that accurate figures on repossessions are very difficult to come by.
At around the same time, the economics committee of the House of Representatives held an inquiry into home loan lending practices. One of the recommendations that came out of its inquiry was that the Australian Bureau of Statistics had begun collecting and publishing annual data on repossessions. This has not yet been implemented, so the current evidence is sometimes anecdotal and by no means comprehensive.
“In the last three or four years, we’ve been seeing an increase in delinquencies,” says Peter Hall, country executive of Australia’s largest mortgage insurer, Genworth Financial. He stresses, however, that this is off a very low base historically. “Even though it has been increasing, it’s still well below our long-term trends,” Hall says. “We’ve got data going back 40 years.”
The Banking and Financial Services Ombudsman says that 2,720 repossession claims were lodged with the Victorian Supreme Court in the 12 months to April 2007 – a 15% increase on the previous year. In NSW, there were 3,642 writs of possession granted by the Supreme Court in 2006. The exact number of how many of these writs were actually executed is unclear.
Hulcombe says that as a valuer he has seen an increase in mortgagee repossessions. “It’s been a little bit area specific,” he adds. “Queensland’s thus far been a little more resilient than some of the other states.”
This is probably due to the continuing strength of that state’s property market. “In a rising property market, anybody having financial difficulties is typically able to sell the property, often at a profit. That allows them to clear their debts,” says Hulcombe. “If you’re in an area where there’s been a reduction in values and [homeowners] are overexposed, it gets to the point where they may not be able to clear the debt.”
Hall says that a rise in interest rates is just one of a multitude of factors that can lead to mortgagee repossessions. “It could range from accident or illness to loss of income or reduced income,” he says.
“What we’re finding in Australia are much higher consumer debt levels. People have plastic cards and other non-housing consumer debts. Unfortunately, they can become overcommitted. Interest rates aren’t the be-all and end-all. It’s the cost of living, be it changes in petrol prices or movements in the consumer price index. They all contribute.”
“Repossessions happen across the board,” says Paul Giezekamp, director of property investment consultancy Property Secrets.
“They’re in every major capital city. No one’s immune from it.”
Giezekamp claims that the idea that repossessions happen only in outer suburbs is simply not true. “There are still some in the inner suburbs,” he says. “There seem to be loans that are given to people who don’t qualify, and when it gets too hard for them – because they shouldn’t have got the loan in the first place – they fall over.”
A different attitude
For some would-be investors, the idea of buying a property at a mortgagee-in-possession auction leaves them feeling a little uncomfortable. After all, there are human stories behind each transaction – families that have been driven to the wall and lost their homes.
John Kovacs, director of NMD Data – the national mortgagee and deceased estate database – has a very different take on this issue. “My whole premise of creating this website is based on the fact that I want people to change their attitude towards mortgagee repossessions,” he says.
“The mortgagee repossessions are the very first properties that start to reduce the value of real estate in an area. If you’ve got people interested in buying those properties, it’s going to maintain the level of pricing in those suburbs. Negative sensationalist press only serves to reduce the price of those properties. If we can create a demand, it’ll buoy the price.” In the long run, this could help maintain property prices in the affected areas.
He also notes that the repossession process is expensive for a lending institution, especially if it doesn’t have mortgage insurance and the property sells for less than what the borrower owes: “The only way that banks can recoup those losses is to increase their fees and charges.” By increasing the demand for such properties, he claims, prices will rise and some of the pressure on fees will be eased.
“I’ve been lobbying all of the major banking institutions to provide a special kind of investment loan so that they can encourage investors and home buyers to buy these mortgagee repossessions,” Kovacs says. “I’m in negotiations with one of the four major banks and it’s researching the viability of this type of investment product,” he adds.
Genuine bargains?
There is a popular urban myth that goes something like this: A real estate agent is appointed by a bank to auction a mortgagee-in-possession property. The agent tips off an investor mate and then fails to market the property. No one except the agent’s mate shows up at the auction and he walks away with the property at half its market value.
Nothing could be further from the truth, says the ABA’s Bell. “The bank/mortgagee has a legal duty to the borrower/mortgagor to act in good faith,” he says. “Therefore, it isn’t simply a case of the mortgagee just wanting to get its money back.
“A bank will select a reputable real estate agent and a reserve will often be set on advice from the agent. The process is largely similar to any other real estate auction process. The mortgagee’s duty requires an appropriate and adequate marketing campaign to be conducted so that in the final result, the best market price on the day is able to be achieved.”
Giezekamp has a different point of view. He acknowledges that banks will get a valuation done and set a reserve, “but if it doesn’t sell [at a reasonable price], they’ve got to see if they want to hold the property or not. Nine times out of 10, they don’t want to hold the property. That’s not their business. Their business is loans.”
Kovacs believes that mortgagee repossessions provide excellent opportunities for buyers. “You’re talking 10–15% off market value,” he says. “A lot of professional investors that I’ve dealt with only want to buy these mortgagee and deceased estate properties because they do go cheaper than any other property, and they constitute the best value for money when property markets begin to tighten up.”
Giezekamp adds that his clients have “a pretty good strike rate with mortgagee-in-possessions. Out of 10 we possibly would get six at a fairly good price.
“If we’re talking about a purchase price of around the $250,000 mark, we’d be getting them anywhere between $210,000–220,000.”
But doesn’t that mean that the market price is $210,000–220,000? If the property has been advertised adequately, surely that’s all it’s worth on the day.
“It depends on who you talk to,” Giezekamp says. “If you speak to the auctioneer from the agency, he’s going to say, well, that’s what the market said. But the reality is, people know that when it’s a mortgagee sale, they’re going to hold back and low-ball. It’s a standard strategy.”
Monique Wakelin, head of research, analysis and communications at Wakelin Property Advisory, is adamant that mortgagee-in-possession properties are “absolutely a smokescreen for investors”.
“The take-home message to investors is to focus on the quality of the asset itself,” she says. “It doesn’t matter how you end up buying a particular property. I don’t care whether it’s by private sale or mortgagee auction or a normal public auction. That’s absolutely incidental to the underlying quality of the asset, which is what really is key.”
Wakelin labels the targeting of mortgagee auctions “an absolutely erroneous concept”. “You might and you might not [get a bargain],” she says. “When something goes up for a public auction, it’s subject to the prevailing market forces, the level of buyer demand and therefore the level of buyer competition.”
Wakelin urges investors to examine the underlying investment quality of any real estate asset. Features such as proximity to the CBD and ready access to good quality schools, health care, leisure facilities, transport and infrastructure should be emphasised, she says.
“If it’s out in the middle of nowhere and it’s isolated, and it’s really hard to get into and around the city, then it’s not going to be a good investment. I don’t care how cheaply you get it for. It’s not going to appreciate in value.”
Yield vs capital growth
Giezekamp challenges Wakelin’s last statement. “I disagree that the value’s not going to go up that much, disagree totally,” he says. “Sydney’s been flat for the last four to five years. It’s only going to be a matter of three or four years before it kicks again and everyone’s going to be saying, geez, why didn’t we find a way to hold on to it? Why didn’t we buy more of these cheap properties? Because they were worth $200,000 back then; now they’re worth $350,000.”
Kovacs adds that while properties in outer suburbs will eventually go up in value, “they must be considered as a long-term investment”. By long term, he means no less than four or five years.
Given the current shortage of rental properties in Australia, yields on low-priced mortgagee properties can be quite high.
“In these outer suburbs, because property prices are starting to fall, yields are rising,” says Kovacs. “You’re getting around 7–8% on your money, which makes it attractive when talking about a property investment.”
One factor that can chew up your yield, however, is spending too much on renovations. “If you were to purchase a mortgagee repossession, you’d only consider doing a cosmetic renovation to receive a better rental return,” advises Kovacs. “That’s basically painting the walls, putting in new carpet and putting it up on the market for rent.”
Wakelin warns that focusing on percentage yields in property investment can be deceptive. “Real property – as opposed to listed property trusts or anything that’s an indirect investment – isn’t a yield-driven investment, it’s a growth asset,” she says. “It’s ultimately the amount of capital growth that gets you ahead of inflation and actually underpins the yield, not the other way round.”
She points out that 3.5% of $1m ($35,000) is more than, say, 10% of $200,000 ($20,000). “So I always encourage investors not to look so much at the percentage yield but to look at the actual dollars, because we’re taxed on dollars, not percentages, and we live on dollars, not percentages.”
Kovacs agrees that buying for capital gain is certainly the optimum investment strategy in a steadily growing market. However, he notes that in the current market where the rates are rising, rental yields are becoming crucial for many investors. “Investors must carefully consider the rental yield as this forms part of the monthly repayment process and assists in the ability to repay your investment loan,” he says. “Make sure you factor in future interest rate rises in your cash flow. Look for long-term investment growth. The market is changing and you must change with it.”
Tracking them down
Lenders don’t advertise their upcoming mortgagee-in-possession auctions. They generally like to keep the process at arm’s length because it isn’t great for public relations. “The marketing of a property by a mortgagee in possession of the property is conducted by a reputable and competent agent who will advertise the property for sale by public auction,” says Bell.
“There’s three of us [in the office], and every single day we actively go through the internet, real estate magazines and newspapers, both city and regional,” he says.
“We locate these properties, and then we contact the agents direct and invite them to advertise on the site. It’s extremely labour intensive.”
The hard work has paid off, and Kovacs, an ex-real estate agent himself, has seen interest in his website skyrocket. Kovacs says he has recorded a 29% jump in mortgagee repossessions advertised on his website in just four months.
“You talk to anyone about mortgage repossessions or deceased estates, and the first thing they start thinking about is ‘bargain’,” he says.
“That’s why the website’s so successful. But you need to do prudent research. Don’t assume these properties are ‘a bargain’.”
