To Pre-sell or Not to Pre-sell

Posted Wednesday, October 22, 2014 Comments (0)

2014 has proven to be the best year for residential construction funding for a number of years, albeit coming off a low base post-GFC. Development sites have been bought at viable prices, interest rates are low, lenders are actually lending and as a result of all this, developers are successfully developing! 

Determining the preferred development funding option invariably comes down to three key factors: 

  1. Presale requirement; 
  2. Leverage; and 
  3. Pricing. 

The key decision which determines the path to finance is whether the project will go to the market seeking sales prior to commencement of construction or be built “on spec”. Once this path is determined it is then a battle for the highest leverage and cheapest pricing. 

With the current level of confidence in the market and competition between lenders, there are arguments to be weighed for both sides of this decision which I have looked at below: 

THE CASE FOR PRESALES: 

1. Cheaper funding 

The cost of funding is a key consideration and determinant in a project’s profitability. Without doubt, a fully presold project is going to be rewarded with cheaper borrowing costs than an unsold project. It is important that the level of impact that the actual cost has on a project’s bottom line is assessed rather than just focusing on the headline rate. 

2. Support for valuation 

Obtaining presales proves market acceptance for your product and in turn supports your estimate of unit values. With valuers tending to err on the side of caution when it comes to putting a number on a project without sales, a few presale contracts will provide a level of comfort as there is no better source of comparable market evidence. 

A favourable valuation report is key to obtaining finance and maximising the level of debt in your project’s capital structure (Property Finance – the impact of valuations). 

3. Mitigate market risk 

Lenders seek presales to minimise their exposure to market risk and ensure their capital is returned upon completion of the project. Likewise, the developer should also seek risk mitigation strategies for their project and preselling stock is top of the list in minimising exposure to fluctuations in market values and ensuring capital preservation. 

THE CASE AGAINST PRESALES: 

1. Commence construction 

immediately In business, time is money and property development is no different with the time in getting stock to market impacting on a project’s bottom line. Holding costs, reaching the market before competing projects and the time value of money are all reasons to expedite the start of construction by avoiding the delays associated with upfront marketing and sales. 

2. Save on marketing commissions 

The cost of marketing commissions for off the plan sales are indicative of the challenge in selling product off the plan compared to completed stock. The ability for a buyer to be able to “touch and feel” something that is potentially one of their life’s largest financial commitments cannot be underestimated. The additional cost of producing marketing collateral to compensate for this also needs to be considered in the cost of selling off the plan. 

3. Prices achievable today compared to tomorrow 

I rarely meet a developer without a bullish view on their project which raises the consideration whether a sale price locked in today will be inferior to where the market will price the product in twelve months when the project is complete. What impact will a 5% market growth during a construction period do for a project’s profitability? 

4. Avoid discount and buyer inducements 

With the toil of obtaining Council approvals now behind you and the excitement of construction about to begin, it is easy to fall into the trap of meeting presale hurdles through discounts or other incentives. This is again driven by the extra difficulty in selling product aided only by architectural drawings and a buyer’s imagination. The same enticements are less likely to be needed when buyers are walking through a completed and furnished unit. 

In Summary… 

The result of both strategies needs to be weighed up in terms of cost, convenience and risk tolerance and we at Balmain Commercial are currently funding projects both with and without the benefit of presales. 

One thing the availability of funding without presales is telling me is that the development finance market is well and truly open for business!


Rhys Adams is a Partner at Balmain Commercial who specialises in delivering commercial property and construction finance solutions. 

Email Rhys: radams@balmain.com.au
LinkedIn: http://au.linkedin.com/pub/rhys-adams/25/a44/985

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