Presale guarantees could help embattled property developers

Wilhelm Jonker, business developer, Paragon Lending Solutions

Many banks structure deals that require a percentage of new 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. Battling a perfect storm of negative market sentiment, low demand and gloomy economic indicators, it is taking developers longer to sell units at the prices they require. For example, they may have sold around 30 units over a weekend just 18 months ago. Now it is taking 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.

Stuck between a rock and a hard place

For a developer who does not make the required sales, the options are fairly bleak.

They could hold onto the land, incurring the rates and other costs, until the market improves enough for them to meet their sales requirements. However, this is a risky move as a stagnating development can scare away potential buyers, and even cause existing buyers to cancel their purchase due to lack of progress.

They could 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.

Finally, they could try 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. And this is where a company like Paragon can offer the solution.

Guaranteed presales is the answer

Guaranteed presales can solve the problem of longer sales cycles. This type of finance is actually not a loan, but rather an underwriting or guarantee for the purchase of an agreed number of units.

By underwriting the balance of the presales (at a fee), developers are able to do two things: First, they can proceed with construction, which solves their most pressing challenge; and second, once they’ve started construction, they are able to sell the units which have been guaranteed, throughout the construction period, at market related prices.

By way of example: 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 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 underway – 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 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 presales 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.

A finance specialist will be able to work with developers to ensure they can access the funding they need, keeping the builders onsite and employed and the money flowing through the entire property ecosystem.