As the property market continues to languish in an extended stretch of doldrums, some astute developers are making use of pre-sale guarantees from finance specialists.
While many are not aware of it, says Wilhelm Jonker, business developer at Paragon Lending Solutions, this solution could make a “significant difference” to developers who are hoping to keep units moving and deals flowing.
“Many banks structure deals that require a percentage of developments to be sold off-plan before the developers can access the senior debt required to begin construction. However, the continued lack of demand for residential property has seen many sales fall short of the bank requirements.”
Developers are battling a perfect storm of negative market sentiment, low demand and gloomy economic indicators, and are taking longer to sell units at the prices they require. He says while they may have sold around 30 units over a weekend just 18 months ago, it now takes months to achieve the same number of sales.
As a result, the banks cannot release the funds that will allow them to begin construction.
“Meanwhile, holding costs are increasing exponentially and developers have building teams retained, waiting to begin work. We are seeing some developers sitting with large amounts of land earmarked for construction or, worse still, partially constructed developments that have stalled because developers are waiting for the banks to release funds.”
Solution in sight as developers struggle to conclude deals in a difficult economy. Picture: Supplied
For a developer who does not make the required sales, the options are “fairly bleak”. They could keep the site, incurring the rates and other costs, until the market improves enough to meet their sales requirements. But Jonker says this is a risky move as a stagnating development can scare away potential buyers, and cause existing buyers to cancel their purchase due to lack of progress.
“They could also sell the land, but in an already depressed market this comes at a high risk. What’s more, they would not recoup the costs they had already sunk into the planning and purchasing of the property.”
They could try to secure alternate funding for the construction, but this would “almost always” be more expensive than the bank debt they were hoping to access.
“This is a lose-lose situation. The banks are happy with the transactions and they are signed and sealed, but in many cases, it’s simply a case of pre-sales not meeting the requirements. The deals are sound, the developers just need a little more time.”
The answer is guaranteed presales that can solve the problem of longer sales cycles.
“This type of finance is not a loan but rather an underwriting or guarantee for the purchase of an agreed number of units.”
By underwriting the balance of the pre-sales (at a fee), he says developers can proceed with construction. Once they have started construction, they are able to sell the units which have been guaranteed, throughout the construction period, at market related prices.
Illustrating this strategy, Jonker says: “Consider a property developer who is building a 100-unit apartment block. He has bank finance that carries a stipulation that 75 units need to be sold off-plan before the bank will release funding to begin construction. However, the developer only manages to sell 65 units and so he cannot access the full bank funding, resulting in delays where he must still pay his teams.
“It is here that a finance specialist (such as Paragon) could step in and put up a guarantee for the remaining 10 units. This triggers the release of the bank funding and construction can get under way - further boosting the saleability of the development.
“Should the 10 units under guarantee be sold before the end of construction, then the finance specialist would simply charge a percentage fee of the value of those units. If, however, the units are not sold, then the finance specialist will purchase them from the developer at a predetermined price. This is a win-win situation for everyone, especially the developer.”
It’s important to remember though, that this type of financial product does not come without its caveats.
“Developers should not be lulled into a false sense of security if they secure pre-sales guarantees. If a development is not enjoying off-plan sales, then there is a question as to its attractiveness and, indeed, whether it should be built at all.”