Off plan developers may ask for different amounts on exchange, how much should you pay and what protection do you have?
You may have bought off plan before, it may be your first time, but no matter how many developments you look at they all seems to have different arbitrary numbers on exchange and completion. With some projects paying 10% on exchange of contracts, and other off plan developments asking for over 75% its worth looking at how these numbers are devised, and whether you should be accepting the numbers on offer.
How are the numbers devised?
While this article will not be able to give exact reasons for every development there are some basics which go into the amount a developer requests on exchange. Generally the rule of thumb is if you are being asked to pay more than 70% you are effectively acting as a lender for a developer (with all the risks lending entails).
Note that the number we should really be looking at is how much is paid before completion, not just how much on exchange. Even if you are asked to pay in instalments before completion, the likelihood is that you are funding the development.
These numbers may be 60% / 50% or 70% and are often based on how much the developer is able to borrow from the bank themselves. Some bank may require the developer to have 50% of the cash in and they will lend the remainder of the money.
Alternatively if the developer can persuade you to part with the lions share of the money upfront, they can reduce the costs of interest paid on borrowing.
So should I not invest in high payment plans?
Fundamentally any payment structure is fine so long as you understand (and are happy with) the inherent risks which come with lending someone money. If you know the developer, know their books, they have a strong track record this may not be an issue, this is exactly what a bond does.
The primary problem which comes with heavy payment plans is that the nature of a developer who needs clients money because a financial institution wont lend to them, are often the developers who have the highest risks, are the least experienced and unable to back the loan with assets. This puts you the property investor in a position where you are expected to know more than the bank.
Developer is promising interest on deposited funds.
Again interest on deposited funds should always be questioned. Who is paying the interest? Who us underwriting this interest payment and will they actually pay it?
While some developers will, others will not and you have very little legal recourse should they decide not to pay this.
Other issues with high payment plans
The other issue with large payment plans (40% plus before completion), is that if the developer needs client money to build – which is normally the case with this model, each stage of the development is held back until units are sold.
A developer may need to sell 30% of the properties before they can even start the build and then more and more for each phase. If the sales take time (which they usually will with high payment plans) then you may have invested early and wait years for completion. The vast majority of off plan developments which have significant delays have high payment models.
So why do we pay any money on exchange?
To be able to build a project there will in most cases be off plan sales, then a show flat is built and in the last 6 months of build the developer will increase prices and offer to the owner occupier market.
Off plan sales benefit both the developer and the investor. The developer sells 80% of their properties early on giving them confidence that they wont have to have a long wait to sell units on completion, they can pay back any lending on the build and focus on the next project. For the investors they can get their unit 10%-15% under what it will be worth on completion by investing early.
With this ‘trade’ between developer, the broker they choose to sell their project, and investor there has to be a commitment which satisfies all that the investor is serious and wont decide to not complete on the development when the build is finished.
Many investors will buy 10+ units in a development and if their commitment was 0% or even 5% on a cheaper development, and they decided they were not going to complete on purchase at the end of the build it can cause a huge amount of problems for the brokers and developers.
So what should you be paying before exchange?
There is, as you would expect, no hard and fast rule here, it is primarily down to the negotiation and advice the master broker has made with developer before the apartments or houses were formerly launched and marketed.
The most important element for an investor is understanding that the development is already funded. The broker should be able to very quickly give you this information – if they can’t is likely their company has not done sufficient due diligence (find someone else quick). If you are happy that the developer doesn’t ‘need’ your money it makes the decision a lot easier.
Next understand how much of your money is insured (normally 10%) and how far the development is into the build. This is important and should be advised by your broker, as a if the development is having the kitchens fitted or on final fit out, your asset is worth much more than if it is a car park with a padlock.
Naturally the best projects will sell often even before build starts so we need some hard and fast common ground.
Normally it is fair to expect under 25% and ideally 10% – 20%. This is usually a position which leaves the developer, broker and investor comfortable, shows development does not need client funding (the land may be valued at over 20% itself) and gives you as an investor an easy way to get their money back should the worst case scenario come to play.
*Note that your 10% insurance may not be needed to pay back to you. In some instances – say if the developer was small and went bust, 10% could be used to replace the developer and complete the project.
Can I negotiate exchange numbers?
Clients must know that everything is negotiable, but the best projects have little to no movement. Logically a broker will not be able to negotiate too much on a development which is selling quickly, however it is always worth the question if you are uncomfortable with the exchange amount being requested.