Warning signs your client’s property is in distress

With a slew of Queensland building company collapses in the news, along with a rapid rise of units under construction from foreign property investors, it’s no surprise that the topic of distressed properties is on the agenda at Jirsch Sutherland’s Brisbane practice. In fact, the rental vacancy rate within five kilometres of Brisbane’s CBD has reportedly reached a record 4.4 per cent – almost double since 2015 – a statistic Partner Chris Baskerville isn’t surprised to hear.

“We’re talking about a scenario where builders’ turnovers went up dramatically – two- or four-fold increases – at the same time massive losses were suffered,” Chris says of the state’s recent construction boom. “People are calling it the ‘profitless boom’, in that builders made more money when they were smaller than when they went for bigger turnovers.

“If you increase the demand for sub-contractor services and there’s no supply to back that up, inevitably prices go up. The thinking is, sub-contractors found themselves in a position where they could demand their own prices and builders had to pay them. Who else are they going to get to do the job?”

By changing the investment criteria for foreign investors, Chris believes the government created a demand for properties which the supply chain struggled to support. “That’s where sub-contractor prices went up, whilst builders were committed to their contract price,” he explains.

Baskerville

Chris says his firm has inherited two sizeable construction insolvency cases this year that point to a shift in the market two years earlier.

“Something happened in 2015 where the knock-on effect was felt early in 2017,” he says. “My theory is that builders were enticed to shoot for the big contracts, and turnovers shot up accordingly, but because of the inflated sub-contractor and building supply costs, they’ve soon found themselves in trouble. Some would have found companies trying to renege on paying those costs, which puts massive cash flow strain and pressure on the business.”

Warning signs to look out for

While there are numerous factors that lead to the defaults on contracts, Chris says there are several warning signs for developers, strata managers, landlords and commercial tenants, that indicate there might be problems ahead.

Developers
  • Foreign buyers cannot settle
  • Domestic buyers cannot settle
  • Sacrifices of deposit, rather than settle (at a lower market value)
  • Breach of financial and non-financial covenants with lenders
  • Rental guarantees: may result in unfit and improper persons occupying units
  • Developers seeking loans from second tier lenders to extract profits from development
  • Pre-sales insufficient to get lenders out
  • Running out of cash prior to completion
Strata managers
  • Foreign investors neglecting Body Corporate commitments
  • Foreign investors won’t tenant their properties
  • Poor quality of construction may affect future sinking fund viability
Landlords
  • Retail tenants who conduct feasibility on 100 per cent occupation of a building may be misguided
  • Retail tenants breaching lease agreements
  • Falls in values of units
  • Falls in face value of rent
Commercial tenants
  • Softening retail sales
  • Dramatic move to online shopping
  • Feasibility studies on 100 per cent occupation of units is unrealistic
  • Taking advantage of vacancy rates (estimated at 15 per cent in Brisbane)
  • Expecting incentives

What to do if your client is in trouble

When it comes to heeding the warning signs that your client might be in trouble, Chris’s message is very clear: seek advice from a qualified insolvency practitioner.

“Avoid unregulated, unqualified and uninsured advisers who have no experience or expertise with distressed properties and insolvencies,” he says. “While we would tailor advice according to the nuances of each scenario, the following are some of the things we would consider generally.”

If your client is a Developer:
  • Find an alternative buyer [foreign/domestic]
  • Work with lenders [forbearance/amnesty]
  • Find a replacement for your primary lender
  • Find alternative investment for the buyer within development
  • Consider incentives to entice purchase
  • Failure to complete project may lead to Receivers being appointed
  • Enforce failed contracts [Liquidation / Bankruptcy of buyer]
If your client is a Strata Manager:
  • Consider enforcement of debts to access benefits under Bankruptcy / Liquidation
  • Engage an independent and local Trustee/Liquidator to sell property
  • Statutory Trustee to exercise power of sale, if necessary
  • Debt is charged to property, ranks ahead of mortgagee (but not land tax)
If your client is a Landlord:
  • Insolvency of Landlord does not mean termination of leases
  • Consider extending bank guarantee to four to six months (potentially in lieu of Personal Guarantee)
  • Consider negotiating to keep tenant at reduced rent to preserve cash flow and lease
  • Consider forbearance to recoup losses at later stage
  • Consider other securities to protect performance

“To keep our economy from slipping into a recession, we have been encouraged to keep on spending, which in turn has created record household – and foreign – debt,” says Chris. “The knock-on effect is that Australia may lose its AAA credit rating and, if that happens, it will make money more expensive. And that will lead to higher interest rates. If interest rates go up by one or even two per cent, there’s economic talk that that would cause up to a million properties to be distressed. It would be carnage.”