Tag: presales

Settlement Defaults – What You Need To Know

It is well established that settlement default risk increases during downturns in the property market. A settlement default occurs when a purchaser fails to complete the purchase of a property according to the terms of a binding sale and purchase agreement. At ASAP, we have personally witnessed an increase in the number of purchasers attempting to back out of such agreements due to recent declines in property prices, particularly presales entered into during the height of the market (late 2021). In light of this, we thought it timely to discuss the options available to developers in the event of a purchaser default.

ADLS Agreement for sale and purchase

The ‘Agreement for Sale and Purchase’ (ASP) comes in many forms however the Auckland District Law Society (ADLS) is by far the most common form of ASP used to transfer ownership of property in New Zealand. The ADLS ASP underpins much of the wealth transfer in New Zealand and the contract law surrounding this agreement is robust and fiercely protected with obligations under ASPs strictly enforced by courts. If a purchaser enters into an unconditional agreement to purchase a property, they are expected to follow through with the purchase.

In the unfortunate event of a purchaser default, the vendor has multiple options available to them under the standard form REINZ/ADLS ASP.

Specific performance

The first option is to seek a court order for specific performance, which would obligate the purchaser to complete the purchase. While this may seem like a logical solution, it is not always feasible. If the purchaser is unable to settle due to a lack of funds, a court order will not change their ability to meet their settlement obligation. Additionally, obtaining a court order can be time-consuming and costly, with no guarantee of success.

Nonetheless, it is perhaps one of the most underrated ways to ensure the performance of a purchaser. Having a court order against you (as a defaulting purchaser) immediately impacts your credit rating and will greatly impair your ability to conduct business in the future. If the purchaser genuinely has the ability to settle, then seeking specific performance may be your best bet. In our experience, a purchaser who feigns an inability to settle will often find a way to settle once face with a court order.

Cancelling the agreement

The second option is for the vendor to cancel the agreement and retain any deposit paid by the purchaser (not exceeding 10% of the purchase price), and/or to sue the purchaser for damages.

It is important for vendors to receive a deposit of at least 10% from purchasers to have this as a viable option. If there is nil deposit, or if the deposit is small, the vendor’s only recourse may be through the courts, which makes it easier for the purchaser to walk away from their contract if the vendor is not prepared to litigate. If the deposit amount is greater, be sure to amend Clause 11.4(b)(i) of the general terms to allow full retention of the deposit.

If you elect to seek damages through the courts, keep in mind that you cannot be put in a better position than you would have been if the original contract had been completed. In this sense, recovery of damages typically includes (but not limited to) the recovery of;

• Any loss incurred on any bona fide resale (you cannot make a claim simply based on a reduced valuation). The resale contract also needs to be entered into within one year from the date when the original purchaser was due to settle.
• Interest on the unpaid portion of the purchase price at the interest rate for late settlement from the settlement date.
• All costs and expenses reasonably incurred in any resale or attempted resale; and
• All outgoings (other than interest) on or maintenance expenses in respect of the property from the settlement date to the settlement of a resale.

The above damages are just some of the examples and all damages claimable at common law or in equity can be recovered by the vendor.

Re-marketing the property

The third option is for the vendor to remarket the property to third parties without cancelling the existing agreement. Clause 11.4(2) of the ADLS ASP allows the vendor to re-market the property – should the vendor enter into a subsequent agreement to sell the property during this process, the original agreement will automatically be cancelled. This may allow you to adopt a multi-strategy approach such as seeking specific performance while at the same time, seeking another party to purchase the property.

Sale to a company

If the purchaser is a company that is still trading, the vendor may seek a statutory demand from the courts as a means of pressuring the company to settle the purchase. If the company as purchaser, owns any other properties (perhaps as part of a wider property portfolio) then a statutory demand can be highly effective.

If a statutory demand is not complied with within 15 working days of it being served, then the company will be presumed to be unable to pay its debts and the vendor (as a creditor) can then rely on this presumption and apply to the High Court to have the company put into liquidation. This will impact the company’s wider portfolio so most will have no choice but to settle the purchase.

Lastly, we recommend considering inserting a personal guarantee clause into the further terms of your ASP. This means that a company that does not own any other assets, will not be able to liquidate and walk away from the sale without personally implicating the directors of the company.

Recommendations

• Have a robust ASP. Selling off-plan is a unique way to sell property. Seek input from both real estate agents (that excel in selling off plan) and lawyers who specialise in property development. This will ensure that you have the appropriate clauses inserted into your ASP as further terms of sale (and can also help with building out a wider marketing strategy).
• Make sure you have a deposit of at least 10% from purchasers.
• Undertake due diligence on purchasers and ensure they have the financial capacity to perform. Inform your real estate agent that you expect them to undertake due diligence on potential buyers. It is also best to avoid speculators and highly geared investors who are more likely to get into trouble.
• Should purchasers indicate that they may be unable to settle, let them know early about your intention to issue a settlement notice. You should also inform them that legal action may follow. While some may see this as an unreasonable and aggressive tactic, signalling is an effective negotiation tool that preserves you position.
• If a purchaser does default on their obligation to settle – act promptly. Serve a settlement notice as soon as possible as detailed above. Again, this preserves your position and gives the purchaser 12 working days to complete settlement after which you can decide on whether you want to exercise other available remedies.
• Obtain expert legal advice.

ASAP Finance is an expert non-bank lender specialising in construction and development finance. Get in touch to explore funding for your next project. 

Exit strategies

Formulating a robust exit strategy is a critical part of the development process. When assessing an application for a development loan, the credibility of a clients’ proposed exit strategy will be reviewed and assessed in detail.

There are several ways a developer can exit a construction loan – the most common strategies being:

• to sell the development down, or
• to hold (and refinance any residual debt).  

No matter the strategy, a lender’s comfort around this area of the transaction is paramount as this is how they expect to be repaid. Failure to clearly demonstrate how funds will be repaid and how you can execute on your strategy will likely result in the funding application being declined.

Learn how to create an exit strategy properly below.

Recycling Profits

Selling down completed stock (be it dwellings or sections) to realise profits is the most common exit strategy property developers adopt. This strategy enables profits to be recycled from one project into another upon completion. This “rinse and repeat” model enables developers to quickly scale their business and grow profits.

Many lenders will lend more aggressively against a ‘sales strategy’. This is because a ‘refinance’ (or ‘hold’) strategy requires the residual debt upon completion of the project to be refinanced. This means that any initial development funding provided by the initial lender cannot exceed an amount the developer will be able to borrower in the refinance market.

Refinancing requires the developer to meet servicing criteria (at a future point in time) which is largely unknown when they start construction. Because lending criteria (and interest rates) are constantly in flux, development lenders will be conservative when providing funding to clients to intend to hold their product.

As a result of the above, most lenders will lend more aggressively when the developer adopts a ‘sale strategy’. This means that selling down properties is a less capital-intensive compared to holding – not only because they can obtain greater leverage but also because the developer’s equity is not tied into the project over the long-term. Therefor, a developer’s return on equity tends to be higher over the short term.

Of course, there is an argument for both exit strategies as over the long term, holding can generate capital gain that can exceed any short-term gain generated through development.

Pre-selling & Lending Criteria

Mainstream lenders such as banks typically require a certain number of pre-sales as a pre-condition to funding construction. In today’s environment, most NZ banks require between 100-130% presale cover to ensure that their debt can be repaid in full upon completion of the project. One of the reasons that (some) banks insist upon a pre-sale cover greater than their debt facility (say 130%) is to ensure that their debt can still be repaid should some purchasers default.

In contrast non-bank lenders have more flexible terms and can fund projects with no (or a limited number of) presales. They also have greater flexibility when determining what constitutes a ‘qualifying presale’.

If you have decided to obtain pre-sales, our suggestion is to always seek ‘bank’ quality pre-sales where possible (regardless of the individual lender’s requirements). Bank quality presales can be typically defined as follows.

• Unconditional (subject only to the issuance of title and CCC)
• Independent contracts sold through an agent
• No related party sales
• Minimum 10% deposit paid (for NZ residents, 20% for non-NZ residents) and held in a solicitors trust account
• Terms consistent with the proposed plans for the project
• Appropriate sunset dates are usually +12 months after the expected completion date
• Sales to individuals (as opposed to a company or trust). If a sale is to a company or a trust then obtain a supporting guarantee from the Directors or Trustees.
• Avoid multiple sales to the same party (as they will typically not be accepted)

Following the above principles will put you in a good place to obtain funding from most lenders.

Should You Pre-sell?

Pre-selling has its perks when it comes to risk management however making such a decision will likely have broader implications for your project, particularly its profitability.

Below we look at some key points developers should consider when making this decision:

Risk mitigation

This one’s obvious – there is a reason that lenders insist on pre-sales. Pre-selling locks in revenue and protects your downside in the event of a decline in property prices. It also establishes a robust (often bankable) exit strategy via a watertight contractual arrangement. Selling at the end of a project will expose the developers to changes in market conditions leading us to our next point…the property cycle.

The property market is cyclical

A firm grasp on what stage of the property cycle we are in will enable us to make more informed decisions when it comes to risk management and risk mitigation. Pre-selling in the growth phase will likely result in you leaving money on the table. A good example is a client who was building two-bedroom townhouses in Epsom, Auckland in 2020. Feedback from real estate agents (and an RV) had suggested an end value of $1.0m per unit. However, our client could see that the market was taking off and was convinced that his product would present better on completion. He decided not to pre-sell, instead listing his properties when they were nearing completion. Between starting construction and completion, the market had moved substantially and our client sold all ten units for greater than $1,150k per unit, a +$1.5M gain in revenue for the project.

Cost Escalations

What is the likelihood of cost escalations during construction? In recent years, property prices have skyrocketed; however, so too have construction costs. This created an interesting predicament for some developers who had sold off-plan. By pre-selling, you are locking in your revenue. This means that any increase in cost (no matter how minor) will directly impact profitability. We all saw the news article in 2021 where developers were trying to renege or renegotiate on pre-sale contracts. This is because construction cost escalation during the build had eroded their profits. In the meantime, property prices were well above their initial presale prices, giving them the incentive to try cancel presales to recapture a project’s margin. In such circumstances, ensuring that construction costs are fixed before starting a project, and retaining/holding back some stock are just some ways to mitigate the impact of escalating construction costs.

Off-plan discount

It is commonly accepted that selling off-plan/before the project has been completed results in the developer selling at a slight discount to market (up to 5% of the purchase price). This can be for various reasons including uncertainty about what will be delivered, time delays, hesitancy on what direction the market may head and so on. However, this is not a blanket rule. Some developers take advantage of this using comprehensive marketing packs and high-quality renders to upsell their development.

Supply and demand: understanding what competing stock is planned for delivery (and when) should inform your sales exit strategy. You may decide to sell on completion if there is no competing stock. If there is lots of competing stock, then it will likely be harder to sell on completion and days on the market will increase. If you are fully drawn on a construction facility, holding costs will quickly erode your development margin. In this instance, pre-selling (at least some) will enable you to reduce debt and de-risk your project.

Price validation: while agents and valuer’s provide an incredibly valuable service, even they can be wrong. If you are building an unusual typology or intend on building a product that is new for the area, then pre-selling will enable to you to test the price point of your product. This will underline revenue assumptions in your project feasibility and allow you to move forward with your build with confidence.

Developing a Sales Strategy

There is no one size fits all approach when it comes to developing a sales strategy. For this reason, instead of detailing an effective sales strategy we have posed some questions which we encourage all our clients to consider before launching their sales campaign.

A good sales agent will help develop a comprehensive sales strategy, and thus we suggest obtaining multiple proposals from various agencies (similar to a tender process) before committing to any one agent.

• Who is the best sales agent to represent you – is there a particular person or agency who would be best suited to sell your product?
• What is the best fee proposal to incentivise your sales agent?
• When is the best time to commence marketing?
• Are you going to pre-sell off plan or sell closer to completion?
• How much stock do you want to release and when? Are you looking to sell 100% of your product before commencing construction or simply sell as many as you need to unlock funding.
• Will one typology be harder or easier to sell compared to another?
• Will selling one product first create a price floor or ceiling for unsold stock?
• How are you going to market your product i.e. what sales channels are you going to use?

Don’t get caught out

Undertaking a development without an exit strategy in place not only undermines your ability to obtain funding but can severely impact the viability of your project.

Pre-sales protect your downside; however, it can come at a cost. Deciding to sell on completion is still a viable strategy, so long as you clearly demonstrate how you will execute this and its rationale.

Being fully drawn on a construction loan facility with no exit in place will result in you incurring unnecessary holding costs which can quickly erode a project’s profit.

Be prepared on how to create and exit strategy; talk to ASAP Finance about funding your next project.