By chance I came across a 2008 article from the Australian that highlighted some of the massive increases that were occurring in prices for rural properties in the Northern Territory at the time. (Barefoot cattleman walking on gold)
One example quoted was Alroy Downs on the Barkly Tableland, which sold in March 2008 for $70 million, when it had been purchased for $30 million only 3 years earlier.
There are likely to have been numerous examples of similar meteoric rises throughout central Queensland cattle properties during the same period. There were certainly similarly large increases in the residential property market as well.
These rises have led to a general belief that property values, be they rural or residential, always go up.
There has been ample evidence of this over shorter timeframes, but it is misleading to believe that values cannot fall, as the last three or so years have shown.
Why is this important? In a single word, debt.
The results of last year’s QRAA rural debt survey showed a 19 percent increase ($2.6 billion) in the Queensland’s agribusiness borrowings since 2009. The average debt per borrower has grown to $1.073 million – a 17 per cent increase.
The survey states that during this period banks have actually tightened lending criteria, so the only way debt could have increased is due to the increase in property values.
Banks can only lend money on sufficient collateral. If we take the example of a property with a valuation of $30 million, where bank criteria allows borrowings up to 40pc* of this value, the owner can borrow $12 million, but when the value increases to $70 million, the owner can increase this borrowing to $28 million!
The increase in debt increases the repayments from $960,000 to $2.24 million per annum, and this is interest only so no repayment of the principal amount. This is a significant increase in required cashflow that has no sympathy for seasonal conditions.
Making money out of cattle can be a challenging business. But when you have increased the required cashflow in line with inflated property values, and not in line with increases in the productivity of the property in question, you are likely to face financial difficulty at some point.
Any reduction in property values will merely add stress to this scenario. Banks do have strict lending criteria and will be looking to maintain the equity values of the money they have lent out. In other words they will want to maintain the agreed 40pc limit. If values have fallen the borrower will find they may be asked to put up more collateral – which they won’t have – or they may find that the interest rate they are charged is increased as the bank prices in the increased risk of the money not being repaid.
This is a familiar scenario in the corporate world where a company has borrowed too much and the cash flow can’t support the repayments. These companies are sold up in the end and rural properties will be no different. Banks will not continue to lend money to a business that does not have the cashflow or equity to support that lending.
As property prices have increased people have increased their debt but many have not had the associated productivity improvements to cover the increased cashflow required. There will be many people in this situation. The ones that come out of it will be the ones that face up to their situation and take positive steps early. It is important to remember that how you got in this situation is completely immaterial. It does not matter that you might believe the last bank manager encouraged you to borrow more then you wanted, the fact is, if you signed for the money then it was your decision and you have to pay the money back.
Recognising financial difficulty can be a challenge as well. Many will blame seasonal conditions, cattle prices, the level of the Australian dollar for short term loss of cashflow. All these reasons will be valid, but in the end the real test will be to check if you have, over time, improved your financial position or has it deteriorated?
Run some simple tests on your statement of position to see how you are travelling. Have the listed assets decreased in value? Has the debt increased? What would happen if your cattle numbers drop due to adverse seasonal conditions? Have you got sufficient cash buffers to restock? If you have any doubt about your financial capacity you need to face up to the problem early.
We would encourage you to take an impartial and objective view of your situation, and to get a second opinion from a suitably qualified professional who will have the courage to question your business model and projected budgets.
What you do not want to do is to get into a position of default by hoping it will all go away when seasons turn favourable. Repaying a loan requires cash flow, not hope.
Default can be of two types; debt services default and technical default. Debt service default will occur when you have not made a scheduled payment of interest or principal. Whereas a technical default will occur when a covenant is violated. This will be a drop in the loan limits due to a drop in property values or where the debt becomes higher than the agreed 40pc of the value of the property.
If you are heading down the path of default you need to be proactive and discuss this with your lender, your accountant or financial adviser. You also need to be very honest with yourself and your family and recognise if you are going to actually be able to trade your way out.
If you don’t address this early the lender will do it for you. This is a situation that you need to be in control of.
Being proactive will help you retain as much equity as possible, if you allow the lender to take control you will likely pay a very high price for your pride.
Many family situations leave the financial decisions to one person. If that is you then remember, a decision not to act is still a decision and it may well have consequences that you and your family will regret in the future.
Graham Financial is a privately owned boutique financial planning practice which has been in operation since 1985. AFSL 327520. The advice in this article is general in nature; advice specific to your circumstances should be sought before acting on this advice. The author of this article can be contacted on (07) 4613 0514, by email at firstname.lastname@example.org or online at www.grahamfin.com.au
* Lending limits, valuations or covenants will vary in line with different lenders and individual circumstances.