Construction finance: To presell or not presell? That is the question

For a developer, securing construction finance can be a real challenge - and things are not getting any easier. 

One significant hurdle builders and developers face is most mainstream lenders such as the banks require a certain number of presales, also known as “off the plan” sales, as one of their many loan requirements. I understand why most lenders might require this; they feel it provides some comfort of how the development finance will be retired, but I do question if presales are really in anyone’s best interests. 

There are generally two reasons why someone would buy a property off the plan; one being, they feel they are buying at a good price and may get some capital growth during the construction period, and the other is that the property is desirable and may sell out prior to completion.

In a rising property market, many people who purchase off the plan have done well, as often the value of the property they purchased a year or more prior values in excess of the contract price; however, this is not always the case.

In recent times there have been many examples of properties reducing in value during the construction phase, often leaving the purchaser in a very tough position. Not only is their property worth less than they agreed to pay, but as the value is less than the contract price, they may not be able to secure finance to complete the purchase. In some cases, this has led to people losing their deposits and the property, or even being sued for not completing the purchase.

Of course, such events are bad for the developer and lender as the properties are no longer worth what was expected. Reductions in value have the potential to compromise the viability of a project and leave developers making less or no profit, or in some cases folding altogether.

Another risk with off the plan purchases is there can be quality and design issues after completion.  The truth is that the property people think they are buying may not be the property they end up with. 

Sadly, it’s not uncommon for developers to change design aspects, reduce floor space and use lower quality finishes than the purchaser thought they were getting. Not to mention any defects that may appear once the project is built. Few purchasers are equipped to deal with such issues and despite the fact they may be unhappy with the product, they still must complete the purchase as they have a contractual obligation to do so. That is of course if they can complete the purchase due to possible valuation issues or a change in their circumstances. A presale does not always lead to an actual sale. 

While there are many good developers, there are a disturbingly high number of cases of poor workmanship and quality issues with buildings that have a high percentage of off the plan sales.   The reason for this is once the properties have been pre-sold, some developers go about trying to cut costs and maximising profits wherever possible. In these cases, I do feel the developer’s motivation may change for the better if they were reliant on the quality of the end product for their profit.

If the strategy for a developer was to sell the properties after completion and not have to secure presales for the lender, they may be more motivated to ensure the properties were of a high quality and presented well, perhaps even building something that really impressed a prospective purchaser when they walked in the door.  This being the case rather than having to discount the properties in order to generate presales, the developer could most likely attract a premium for the product which would be in their interests as well as the lender. 

Not all lenders require presales; there are options such as non-bank and private mortgage lenders which don’t require presales in order to approve construction finance. From a lender’s perspective, if they have confidence in the developer/builder and the viability of the project itself, I do question if demanding a level of presales is ultimately a good thing for them or the developer.