6 Actionable Lessons Property Investors Can Learn From Blue Chip’s Failure

Introduction

6 Actionable Lessons Property Investors Can Learn From Blue Chip’s Failure

Kiwi property investors lost $85 million when Blue Chip, a property investment company, fell over.

The company had sold properties off-the-plan to Kiwi investors, while the property market was running hot.

But when the financial crisis hit between 2008 and 2010, hundreds of investors lost their life savings. Some were even forced to declare bankruptcy.

Over 10 years later, investors are rightly wary of repeating past mistakes.

This article covers the 6 crucial lessons investors can learn from Blue Chip’s failure, along with the actions you can take to stop history repeating itself.

 
Lesson #1 – Hydraulicing

Lesson #1 – Use an independent valuer – because Blue Chip’s property prices were hydrauliced

Blue Chip sold properties for more than they were worth.

For example, a property worth $300k on the open market may have been sold to an investor for $350k.

Today we call this hydraulicing, where companies use underhanded tactics to puff up property prices.

In the Blue Chip case, the company typically sold blocks of apartments.

They’d sell a handful of units at high prices to willing investors. They then used those sales as evidence for what the rest of the properties were worth when seeking a property valuation.

In simple terms, they were saying, “Look, these apartments sold for $350,000, so the rest must be worth $350,000 too.”

Usually, the property valuer was associated with Blue Chip and may have received payment for providing an above-market valuation.

With that piece of paper in hand, Blue Chip sold the rest of the properties at the above-market price. And using the valuation as evidence, banks would agree to lend investors the money to complete the purchase.



What are the key lessons?

Property investors need to use an independent property valuer.

Generally, this is now enforced since banks require you to use their independent valuation process when applying for a loan.

You’ll be randomly assigned a valuer, and when they make their assessment, they send it directly to the bank.

This means you don’t have an opportunity to argue the assessed value before banks read the valuation.

Even so, if a property seller provides their own valuation as part of a sales process, take it with a grain of salt.



Actionable Takeaways

  • Use an independent valuer when assessing a property transaction. You need to be sure that you’re not overpaying for a property.
Lesson #2 – Financial Advisers vs Developers

Lesson #2 – Beware of financial advisers that sell their own properties

The next issue was an inherent conflict-of-interest in Blue Chip’s business model.

The company presented itself as offering advice while also sourcing investment properties.

But Blue Chip sold properties, which the company itself owned.

If Blue Chip wanted to recommend a particular block of apartments, they would buy the entire building from a developer and re-sell the units individually.

This is an issue because Blue Chip portrayed itself as offering independent advice. But in reality, their adviser’s hands were tied. They could only recommend their own product.



What are the key lessons?

If you want independent property advice, then you must use independent advisors.

Blue Chip wasn’t able to do this. Because even if the properties were thought to be suitable investments, the company couldn’t walk away from a project if it didn’t meet market demand.

Even today, this still happens.

Some developers represent themselves as financial advisors, claiming their properties are suitable for investment.

In some instances, a developer may be right – it may be a good investment.

But it’s hard to tell if their claims are valid because – of course, they’re going to say that.

That’s why investors do themselves a favour when they’re wary of taking property advice from a person who only has their own properties to recommend for investment.



Actionable Takeaways

  • Ask your property coach if their company owns or is developing the property they’re recommending. Be wary of taking property advice from a developer.
    • For instance, here at Opes Partners, we don’t develop our own properties.
    • Instead, we find properties which we believe are suitable for investment. We then charge a fee to the developer.
    • This means we can be independent and aren’t incentivised to recommend one property over.
  • If you decide that the right decision for you is to purchase directly from a developer, then double-check all their investment claims. After all, they’re in the business of building properties, not in the business of offering investment advice.
Lesson #3 – Contemporaneous Settlements

Lesson #3 – Beware of contemporaneous settlements and short-term thinking

One of the most significant issues with Blue Chip was that they sold the same property to multiple investors.

These properties were still under construction, so all these settlements would happen at the same time – what’s known in the industry as a contemporaneous settlement.

This is a bit tricky, so let’s go through an example of how this works in practice:

Blue Chip has a property to sell, which is currently under construction and will be completed in 12 months.

The company sells the property to Investor A for $300,000. That investor pays a deposit and signs a contract to pay the rest of the money once the property settles.

Here’s where things start to get complicated.

3 months later, Blue Chip organises for Investor A to sell the property to Investor B for $350,000 – $50k more – with the money to be paid on the same day that construction is finished.

Investor A is happy because on the day the property is finished, the money changes hands, and they’ll have made $50,000.

That’s because Investor B will pay them $350k for the property and they only have to pay Blue Chip $300k (plus any commission).

Blue Chip would then tell Investor B that in 3 months they’ll re-sell the property to another investor at an even higher price. This latest transaction would settle on the same day as the other ones.

But then the dance stopped.

When the company fell over, some investors were forced to buy properties they never intended to purchase.



What are the key lessons?

Firstly, investors need to be very wary of any ‘make money quick’ schemes.

Because in the end, one investor was left paying more money for a property than it was worth.

And the cost is too high if you’re the person left holding the property with the pumped-up price.

The second lesson is one that the banking industry has learnt. Warning bells start to flash at the bank when they’re asked to lend on a property with multiple settlements happening on one day.

That’s why first-time investors should be wary of buying from a vendor that doesn’t own the property already.

That doesn’t mean all contemporaneous settlements are dodgy. For instance, a developer building a house will sometimes pay for the land the same day you pay them for the home. That’s industry standard.

But, purchasing a property from Investor B, who’s buying it from Investor A, who’s buying it off a property investment company, who’s buying it off a developer, should sound warning bells.



Actionable Takeaways

  • If your property coach talks about quick money or investing for the short term, be wary. For instance, here at Opes Partners, we advise investors to have at least a 10-year time horizon when committing to a property.
  • If a property seller’s name isn’t on the registered council title, ask why that’s the case. There needs to be a transparent and honest reason why.
Lesson #4 – Licensed Real Estate Agents

Lesson #4 – First-time property investors should only sign a contract with a real estate agent

Investors signing contracts with Blue Chip weren’t covered by consumer protection laws.

Because the company was typically the owner of the properties they were selling, the transactions were classed as private sales.

This meant that transactions didn’t need to be brokered by a real estate agent, so weren’t covered under the Real Estate Authority (REA). This is the body that regulates real estate agents within New Zealand.

This meant that Blue Chip didn’t need to follow certain best practices, such as keeping a purchaser’s deposit in a solicitor’s trust account.



What are the key lessons?

To get protection from the government when it comes to property sales, you need to work with advisors who operate under the relevant regulations.

Increasingly, the relevant bodies are the Financial Markets Authority and the REA.



Actionable Takeaways

  • If you’re a first-time property investor, make sure your sale and purchase agreement is signed with an authorised real estate agent. This ensures you’re covered by consumer protection laws.
Lesson #5 – Trust Accounts

Lesson #5 – Keep your deposit in a lawyer’s trust account

To secure their ability to purchase a property, the buyer will generally pay a 10% deposit.

Today, these funds are held in a lawyer’s trust account. They aren’t paid to a developer or property’s seller until settlement – the day the money changes hands, and you officially own the property.

In Blue Chip’s case, 2 things happened.

First, investors were asked to pay 30% deposits – 3x the size a regular purchaser would pay.

And, instead of keeping the deposits in a lawyer’s trust account, Blue Chip used the money to fund their business.

This became an issue when the company folded. Because the money had already been spent, investors couldn’t get their deposits back.

Some were left out of pocket by hundreds of thousands of dollars. In some instances, this even put the investor’s own home at risk.



What are the key lessons?

The critical lesson for property investors and the industry is ensuring that any deposits paid are held in a lawyer’s trust account.

The funds must not be used as cash flow to fund a building project. This is particularly important when working with a developer.



Actionable Takeaways

  • Ask your property lawyer to confirm that any deposit you pay will be held in a solicitor’s trust account, so you won’t lose it if the developer faces bankruptcy.
Lesson #6 – Falling House Prices

Lesson #6 – Consider the possibility that house prices could fall

Because Blue Chip was re-selling the same property between buyers, these purchasers needed the property market to continue appreciating over the short term.

There was no consideration of what would happen if prices quickly fell.

But in actual fact, property prices fluctuate in the short term. And this is where investors can end up paying more for a property than it’s actually worth.

This was particularly risky in the early 2000s because property prices were being puffed up – and the banks required lower deposits then than they do today.

With natural, long-term appreciation in the property market, some of these investors will now have made money on these properties.

But the issue is that they got themselves into a position they never expected to be in:

  • buying a property they never expected to buy
  • at a price that was more than the property was worth.
  • Ask your property coach what would happen if prices fall in the near term. They need to be honest and discuss this as a possibility. Be wary if they are not comfortable dealing with this question.



What are the key lessons?

The banking industry learnt a good lesson.

Due to increased regulation and risk aversion, banks now typically require a minimum 20% deposit for most properties.

At the time of writing, investors require a 40% deposit when purchasing existing properties.

This means investors are less exposed than previously if property prices fall.



Actionable Takeaways

  • Ask your property coach what would happen if prices fall in the near term. They need to be honest and discuss this as a possibility. Be wary if they are not comfortable dealing with this question.


Bonus Lesson: Trust

Bonus Lesson: Make sure you only take advice from people you trust

Perhaps the biggest issue with Blue Chip was their lack of moral backbone.

The company was founded and run by Mark Bryers.

In late 2006, Blue Chip’s board of directors received a 13-page briefing that detailed the amount of money Bryers had drained from the company. It was said that Bryers was dragging the company towards insolvency.

In 2010, the Serious Fraud Office (SFO) investigated the company.

Although they found evidence of wrongdoing, the company was not prosecuted in court. That’s because the SFO felt the evidence was not strong enough to result in a conviction.

The regulator investigated allegations that Blue Chip staff had:

  • misused purchasers’ deposit money
  • changed purchasers’ loan applications without permission to make it more likely that lenders would advance Blue Chip clients’ money
  • provided fake sale and purchase agreements to developers so they’d be paid fees early
  • conducted false accounting i.e. made up revenue that never existed.

The company's corporate culture appears to have been rotten to the core.

Incidentally, Bryers is currently facing court proceedings for allegedly committing tax fraud in Australia.



Actionable Takeaways

  • Only work with property coaches and professionals that you trust. If your senses start tingling, get out of there.
Conclusion

All the lessons to be learned from Blue Chip's failure

Blue Chip was a perfect storm of failure. Many factors came together in an unfortunate mess where well-meaning Kiwi investor got burnt.

Looking back, we can learn from these mistakes.

The finance, property and investing industry has changed significantly over the last decade. Regulation and compliance are enormous, and the government now takes a more active approach to protect investors.

But unscrupulous businesspeople will always try their luck. They’ll find new ways to make a quick buck and take enormous risks to earn outsized rewards.


Property investors should always be on the lookout and on guard to ensure their investment advice is independent and trustworthy.

And armed with these 7 lessons and actions, you’ll be well on your way to avoiding past mistakes:

  1. Use an independent valuer
  2. Beware of advisers selling their own properties
  3. Beware of contemporaneous settlements and short-term thinking
  4. First-time property investors should only sign a contract under the authority of a real estate agent
  5. Keep your deposit in a lawyer’s trust account
  6. Consider that prices could fall
  7. Make sure you only take advice from people you trust