SINGAPORE (July 3): Living above the clouds has lots of appeal, going by how nearly all of the apartments at a 319m-tall skyscraper in the middle of Melbourne have been sold. In 2015, a penthouse on the 100th storey of Australia 108, as the tower on Southbank Boulevard is called, sold for A$25 million. More recently, two remaining penthouse units on the 97th storey were being marketed here by List Sotheby’s International Realty, Singapore for A$12 million ($12.7 million) each.

The developer of Australia 108 is World Class Global, a company that was recently listed on Catalist. At its IPO, shares in WCG were sold at 26 cents each, which was more than twice the company’s net asset value (NAV) of 11.4 cents a share. Interestingly, while the company has three property development projects in Australia underway, it has not posted any revenue for the last three financial years. For FY2016, it reported a loss of $6.3 million. Still, the stock climbed as much as 7.7% above its IPO price when trading began on June 15. It closed on June 29 at 26 cents.

According to WCG’s listing prospectus, it has recorded pre-sales worth some A$1.2 billion. Buyers of the properties it is developing have only put up an initial deposit, and are due to pay the balance only when they collect their keys. At end-2016, WCG had some A$124.6 million in deposits in an escrow fund.

How is WCG funding its development if there is little cash flow coming from the buyers? The answer is, quite simply, by taking on lots of debt. As at end-2016, the company had a debt-to-equity ratio of more than five times. Of the $462.5 million in total debt on its balance sheet at that point, some $228.5 million was owed to its parent Aspial Corp, a jeweller that expanded into property development. WCG pays interest of 5.25% to 5.75% on these loans from Aspial.

The amount WCG owes Aspial might have since risen. In WCG’s prospectus dated June 6, the company disclosed that it had drawn down $362.8 million, including interest, as part of an unsecured $400 million revolving credit facility extended by Aspial, to finance its working capital requirements.

Debt-fuelled growth Aspial’s property development arm is known as World Class Land. WCG holds the group’s Australian and Malaysian property businesses. Notably, in 2014, two Melbourne sites were acquired for a combined A$69.1 million. The buildings that occupied the sites were later demolished to make way for swanky new developments. The Australia 108 project, which has 1,103 units, will be completed in six stages from 2018 to 2020. The 456-unit AVANT that was launched in June 2015 is expected to be completed by end-2018. Both projects are nearly all sold, off-plan.

WCG also has a “mega-integrated development” in the CBD of Cairns, in which Aspial had first invested some A$18.9 million. In October last year, WCG launched the first phase of the mixed-use development, dubbed Nova City. Prior to WCG’s IPO, Aspial funded these overseas projects as well as its projects in Singapore partly by taking on debt on its balance sheet. As at end-2016, the group had a debt-to-equity ratio of more than three times.

Some of its debt is in the form of bonds issued to local retail investors. Its first retail bond was launched in August 2015. It raised $150 million at 5.25%. Those bonds mature in 2020. Seven months later, in March last year, Aspial sold its second round of retail bonds. The response was overwhelming, and the company increased the issue from an original $50 million to the maximum of $200 million.

According to filings from Aspial, a large part of the proceeds of those bonds went to the funding of overseas property projects as well as to the refinancing of borrowings; in August 2016, the company redeemed its $100 million 5% notes that were due, and in January this year, it redeemed its $80 million 4.5% bonds. Aspial has another $100 million of bonds due in November 2018, which is around the time that WCG expects to start recording the bulk of the sales of its apartment units in Melbourne.

New chapter of growth? Now, the listing of WCG might have opened a new chapter in Aspial’s push to grow its overseas property development business. According to WCG’s prospectus, as part of a restructuring exercise in September 2015, 90% of its shares were transferred from World Class Land to Aspial for roughly $14.4 million. This amount was offset against part of Aspial’s loans to World Class Land. At IPO less than two years later, WCG sold 136 million shares priced at 26 cents each, which would have valued the whole company at $235.5 million, based on the total post-IPO share capital of 905.7 million shares.

Of the 136 million shares that were sold, 36 million were vendor shares. The vendor shares came from CEO David Ng Sheng Tiong and his brother-in-law Koh Wee Seng, the company’s non-executive chairman. Koh is also CEO of Aspial, and his brother Wee Meng is chairman and CEO of real estate developer Fragrance Group, which has also expanded into Australia. Aspial now has an 81.7% stake in WCG. Koh and Ng are WCG’s second- and third-largest shareholders, respectively, with stakes of 2.51% and 2.46%.

WCG says in its prospectus that the net proceeds from its IPO of $21.95 million will not be used to pay off debt. Instead, it intends to use some $18.8 million of it for the acquisition of properties and costs related to its developments.

Risks Down Under The big question now is whether WCG’s key projects in Australia will be completed without a hitch. If everything goes smoothly, the company could report a surge in revenue and earnings a couple of years from now that will quickly inflate its NAV. However, if there are delays, or if its customers walk away, the company could be left in a financial bind.

Property buyers in Australia who buy “offplan” need only pay a deposit, typically 10% of the sale price. While these buyers may seek pre-approval from banks for financing, the banks do not actually formally assess debt service ability or provide unconditional financing approval until settlement is ready to take place, according to a report last year from the Reserve Bank of Australia.

“Instances of buyers failing to settle their apartment purchase can affect the financial position and credit risk of apartment developers, leading to potential losses for lenders,” notes the RBA report.

At the same time, new developments in Australia typically attract a high proportion of foreign buyers, because foreigners are restricted to new development sales. WCG says in its prospectus that the buyers of units in Australia 108, AVANT and Nova City are mainly those in Australia, Malaysia, Singapore, Indonesia, China and Hong Kong. According to data from Australia’s Foreign Investment Review Board (FIRB), direct foreign investment in the country is being driven by residential real estate transactions. In fact, FDI in the real estate sector was up 36.8% in 2015. The real estate sector is now the third-largest recipient of FDI in Australia, after the mining and manufacturing sectors. At end-2015, the sector received 8.7% of Australia’s total FDI.

According to FIRB, Australia approved investments from China totalling some A$47.3 billion in FY2016. It was the third year in a row that China was the largest source of approved investment, which was “driven by continuing approvals in the real estate sector”. Three-quarters of all residential real estate approvals were for purchases in Victoria and New South Wales. In fact, Australian government data shows that foreigners buy one in five new homes in those two states, or at a rate of A$8 billion a year, reflecting strong demand, particularly in Melbourne and Sydney. A recent Credit Suisse report noted that Chinese buyers account for 80% of these sales.

Could the capital controls implemented by the Chinese government now heighten the settlement risk faced by Australian developers and their bankers? “[Settlement risk] is a concern for lenders,” says Dominic Brown, Cushman & Wakefield’s head of research, Australia and New Zealand. He adds that there has been only a small increase in buyer defaults so far. Still, “it is for this reason banks like to see larger deposits and fewer sales to offshore investors”.

More risk-taking ahead? Even if WCG manages to complete its existing projects and books a surge in revenue and earnings in the years ahead, it may well decide to maintain high levels of debt as it pursues more projects. Besides its three existing projects in Australia, WCG has a 16,351 sq m plot of land in Cairns with plans for a mixed-use development. It also has two smaller plots of land in Brisbane, which have been earmarked for residential property developments. In addition, the company has 28 properties in Penang, Malaysia, comprising mainly pre-war shophouses.

What does all this mean for WCG’s investors in Singapore?

As the company itself notes in its prospectus, there are a variety of risks to its business, which is a capital-intensive one in a country with laws and regulations that differ from those of Singapore. While a heavily leveraged company such as WCG has the potential to generate very high returns, there is also a significant risk of things going wrong.

So, it’s probably best that investors not have their heads in the clouds if they choose to own the stock.

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