In the world of Property Developers, the concept of selling "off the plan" is one that pops up quite regularly. Essentially, it means selling a development project based on the approved plans, before it's actually built.
Lending institutions love off the plan sales, because it helps them to feel confident the money you're asking for will be paid back when those sales are completed. It's often a requirement of construction finance in order to minimise their risk.
As a Property Developer, though, should you consider off the plan sales, regardless of whether or not your lender requires them?
My answer - it depends!
I know - you don't like that answer! So let's delve further into the basics of selling off the plan. That way you'll at least be prepared if it comes up as being something you need to pursue.
How Does It Work?
You have a property to sell. You have a buyer. You create a sales contract. Sounds pretty normal so far, right?
But in fact it's a special type of contract with a settlement date a long way into the future. Essentially, it's based on you promising that you're going to build the dwelling, and the buyer promising to buy it.
So as a starting point, you need to make sure you have a good property lawyer who understands how this type of contract works. They're generally a lot more detailed than a regular contract as they need to contain information about the build part of the process.
The buyer still pays a deposit, but as usual, this goes into a lawyer's trust account. And it stays there until the contract of sale goes through. So DON'T make the mistake of thinking you will have access to those funds. Lenders, however, will be happy to know the funds are sitting there.
The Sunset Clause
There's also a sunset clause in the contract. The purpose of this is to give buyers a way out if you take too long to complete the development project (or potentially don't build it at all). The sunset clause allows the buyer to exit the contract without penalty.
From a developer's perspective, you should aim to make the sunset clause as long as you can. If you think the project is going to take 3 years, make it 4 years, for example. For a buyer, they want it to be shorter, so they can pull out quickly if things don't appear to be happening, or simply as a way to put pressure on you to get moving.
Either way, be aware that if the sunset clauses in your off the plan sales start expiring, your lender is NOT going to be happy. So do your best to give yourself plenty of time to complete the project, or you may find yourself in trouble financially.
What Is The Property Worth?
As part of your feasibility for the development project, you will have looked at the sales price of comparable properties in the area. You'd therefore assume that's the sort of price you could sell your properties for off the plan, right?
Wrong. Although comparables give you an indication, you're fighting a number of other factors.
First up, buyers know they're taking a big risk buying off the plan. There's no guarantee the project will actually happen, or what the build quality will be like, and a whole lot of other issues. So in return for taking that risk, they want a discount.
It's even worse if they're the first buyer to buy one of the dwellings in the development, because they're likely to have the biggest wait for their property. As an example, if you need 5 off the plan sales to get funding, nothing is going to happen unless you get the other 4 sales. Sometimes you will have to cut the price even further on the first sale to get the ball rolling.
Valuers, too, are notorious for valuing off the plan sales lower, for many of the same reasons. This can negatively impact a buyer's ability to get finance.
Generally, local agents don't have a lot of experience selling off the plan properties and so are less likely to get high sales prices for the properties. And while you can potentially use a project marketer who specialises in this type of sale if your project is big enough to be of interest, that solution comes with higher fees.
This erosion of the sales price from different angles is one of the big reasons most developers only sell the minimum number of properties required off the plan to keep the lender happy, and hold the rest to sell after completion.
Should I Avoid Selling Off The Plan?
Given all the points I made above, you might think that selling off the plan is always a bad idea. But that's not necessarily the case.
If you're in a rapidly rising market, yes, you're potentially locking in sales at a lower level than you would get if you could wait until completion.
But if you're in a falling market, you can use off the plan sales to protect your price point. You can lock in an acceptable level of profit, knowing that even if prices drop further, your sales prices are enough to cover your costs and deliver at least some profit. So they can be used as a way of hedging against the risk of a market downturn.
Good or bad, the fact is that very few property developers avoid selling off the plan forever. It's a big part of risk management for lenders, and sometimes it can actually be beneficial for a developer as well.
So make sure you have a lawyer who understands this type of contract very well, be very conscious of timeframes and price points, and you should find off the plan sales are a useful tool in your Property Developer toolkit.
Lending institutions love off the plan sales, because it helps them to feel confident the money you're asking for will be paid back when those sales are completed. It's often a requirement of construction finance in order to minimise their risk.
As a Property Developer, though, should you consider off the plan sales, regardless of whether or not your lender requires them?
My answer - it depends!
I know - you don't like that answer! So let's delve further into the basics of selling off the plan. That way you'll at least be prepared if it comes up as being something you need to pursue.
How Does It Work?
You have a property to sell. You have a buyer. You create a sales contract. Sounds pretty normal so far, right?
But in fact it's a special type of contract with a settlement date a long way into the future. Essentially, it's based on you promising that you're going to build the dwelling, and the buyer promising to buy it.
So as a starting point, you need to make sure you have a good property lawyer who understands how this type of contract works. They're generally a lot more detailed than a regular contract as they need to contain information about the build part of the process.
The buyer still pays a deposit, but as usual, this goes into a lawyer's trust account. And it stays there until the contract of sale goes through. So DON'T make the mistake of thinking you will have access to those funds. Lenders, however, will be happy to know the funds are sitting there.
The Sunset Clause
There's also a sunset clause in the contract. The purpose of this is to give buyers a way out if you take too long to complete the development project (or potentially don't build it at all). The sunset clause allows the buyer to exit the contract without penalty.
From a developer's perspective, you should aim to make the sunset clause as long as you can. If you think the project is going to take 3 years, make it 4 years, for example. For a buyer, they want it to be shorter, so they can pull out quickly if things don't appear to be happening, or simply as a way to put pressure on you to get moving.
Either way, be aware that if the sunset clauses in your off the plan sales start expiring, your lender is NOT going to be happy. So do your best to give yourself plenty of time to complete the project, or you may find yourself in trouble financially.
What Is The Property Worth?
As part of your feasibility for the development project, you will have looked at the sales price of comparable properties in the area. You'd therefore assume that's the sort of price you could sell your properties for off the plan, right?
Wrong. Although comparables give you an indication, you're fighting a number of other factors.
First up, buyers know they're taking a big risk buying off the plan. There's no guarantee the project will actually happen, or what the build quality will be like, and a whole lot of other issues. So in return for taking that risk, they want a discount.
It's even worse if they're the first buyer to buy one of the dwellings in the development, because they're likely to have the biggest wait for their property. As an example, if you need 5 off the plan sales to get funding, nothing is going to happen unless you get the other 4 sales. Sometimes you will have to cut the price even further on the first sale to get the ball rolling.
Valuers, too, are notorious for valuing off the plan sales lower, for many of the same reasons. This can negatively impact a buyer's ability to get finance.
Generally, local agents don't have a lot of experience selling off the plan properties and so are less likely to get high sales prices for the properties. And while you can potentially use a project marketer who specialises in this type of sale if your project is big enough to be of interest, that solution comes with higher fees.
This erosion of the sales price from different angles is one of the big reasons most developers only sell the minimum number of properties required off the plan to keep the lender happy, and hold the rest to sell after completion.
Should I Avoid Selling Off The Plan?
Given all the points I made above, you might think that selling off the plan is always a bad idea. But that's not necessarily the case.
If you're in a rapidly rising market, yes, you're potentially locking in sales at a lower level than you would get if you could wait until completion.
But if you're in a falling market, you can use off the plan sales to protect your price point. You can lock in an acceptable level of profit, knowing that even if prices drop further, your sales prices are enough to cover your costs and deliver at least some profit. So they can be used as a way of hedging against the risk of a market downturn.
Good or bad, the fact is that very few property developers avoid selling off the plan forever. It's a big part of risk management for lenders, and sometimes it can actually be beneficial for a developer as well.
So make sure you have a lawyer who understands this type of contract very well, be very conscious of timeframes and price points, and you should find off the plan sales are a useful tool in your Property Developer toolkit.
