Two controversial reports with wordy titles were released within a month of each other this year: the report from the “Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry” (Feb 2019); and a “Building Confidence Report Implementation Plan” (March 2019). Banks and Building.

Both were comprehensive, but a possible major crossover between the two reports went un-detected.  In the list of culprits to be held to account in the study of shoddy buildings, particularly apartments, one guilty party went unnoticed: the banks.

Despite the much-resisted Royal Commission’s astonishing exposures on banks misbehaviour, their role in encouraging developers and builders to build badly went unremarked in both reports.

Architects, certifiers, engineers, and contractors all got a bollocking in the construction industry report, as you’d expect, but what’s this about banks? Can they be contributing to bad behaviour on site? Yes indeed.

To understand how, you need to follow the building process, and it goes like this. Once a developer (or builder) has an apartment building approval in hand they need to raise the finance to construct it. Established large scale developers either have their own funds or easy access to finance.

But the increasing number of medium to small players who are developing units for sale need to go cap in hand to a bank for a ‘construction loan’. This loan is only for the duration of the construction process, to enable the builder to buy materials and pay labour and has to be re-paid when the units are sold.

The banks want security for the construction loan, by having a guarantee that the units will be sold, so their money is ‘safe’. They do this by requiring the developer to make ‘off-the-plans’ sales.

This often entails a whole, or part, apartment being built in a disposable display suite, with computer generated graphics on the walls, in glossy brochures and other collateral, together with large-scale models and sample finishes. It’s an extra cost that is added on to the apartment costs, without adding anything to the actual apartments.

Real estate agents then sell the apartments out of the display suite, at the best price they can taking a holding deposit of 5 to 10 percent of the apartment cost.

They keep selling until they reach the bank’s required level of apartment sales, at least 50 percent, but rising to 80-100 percent for first-time developers, especially as the market heated up. By forcing developers to sell early it committed them to sales at the current ‘market price’, but the value of the unit in the future increases in the rising market of the last 10 years.

The major downside is that the developer now knows, to a large extent, how much money they will make, variously called the gross return (GR) or return on investment (ROI), and hence the possible profit seems fixed. There is no incentive to build in quality, to the high standard that would be required for sales to be made to purchasers walking through a finished apartment.

On the contrary the developer / builder loses all incentive to finish the apartment as per the plans, but is encouraged to ‘dumb it down’ to increase the profit margin within the GR. Most contracts for ‘off the plan’ allow for up to 5 percent changes in the design, but what that might be is not spelt out, leaving a giant loophole.

Builders reduce the fit-out, build to a lower quality and even to leave things out: all in all, they build shoddy. And the signed-up purchaser can do nothing about it. The market has moved up, the shoddy apartment is now worth say 10-15 percent more than they paid.

A classic Hobson’s choice. The developer is standing there with a cheque for the deposit in the back pocket, ready to hand it back, knowing they can resell the unit for 10 percent more profit; or the purchaser is financially blackmailed into accepting it, locked into a bank loan. They pay the balance owing, hoping they can re-sell the shoddy apartment in a year or so when prices improve even further.

The market is flooded with these poorly built apartments; the owners’ corporations try to hide the problems in the hope that the building doesn’t get a bad reputation, so that the strata owners can sell again, at a profit, without the defects being addressed.

The purchaser is dudded with a poor product, the developer is dudded with a loss of profit, so who benefits? Banks. They make money at every turn, in the construction loan and in the first and subsequent mortgages.

Selling ‘off the plan’ is the scourge of building good units. The builders hate it as it lowers their profit, purchasers hate it as they rarely get what they are expecting. But Australian banks are amongst the most profitable in the world.

On a final note: the “Building Confidence Report Implementation Plan” referred to above is a response to the Shergold-Weir report on “Building Confidence - Improving the effectiveness of compliance and enforcement systems for the building and construction industry across Australia”.

This report never found the real source of shoddy building because they were directed to look in all the wrong places. More on that in next week’s Tone on Tuesday.

Tone Wheeler / environa studio

The views expressed are solely those of the author and are not held or endorsed by A+D.