We were lucky to recently co-host an event with OPES partners and subsequently feature in their popular property academy podcast. The event was directed at developers and extolling the virtues of pre-sales and how they help property developers.

Subsequently we thought it would be helpful to put a blog together that details everything you need to know around pre-sales. We will cover off what they are, why are they important, who are the best buyers, what to look out for when preparing a pre-sale contract and lastly when and how to get them.

What is a pre-sale?

A pre-sale is a terminology for a sale of a property that has been made before the property has been built. Most often it refers to sales made prior to construction commencing on a project.

Pre-sales can also be referred to as off-plan sales indicating that the property has been bought based on the plans provided rather than the physical product.

Why are they important?

Firstly, it is important to acknowledge that a development may proceed without pre-sales. They are not crucial to obtaining finance or completing a development, however, they do provide some advantages.

Quite simply pre-sales are a good tool of managing your risk. A pre-sale achieves a two distinct outcomes;

1. It proves the market acceptance of the product. When you are building property for sale it is important that you are building a product that people want to buy. Developers will know it takes a lot of capital to deliver property and if you are building something that people do not want that can be a very costly mistake.
   Selling properties off plan proves that there is a market to purchase those properties and gives you an indication of what price they will sell for.
2. It ensures a return on your capital / repayment of your debt when you complete the project. Property development carries many different risks including consenting, delivery and sale. Typically the consent risk is taken care of by the time you look at delivery or sale (further below). By selling down properties off the plan you will remove or mitigate some of this risk allowing you to place greater focus on delivering the product. Once you have achieved that then, assuming your contracts are robust, you should realise your return from those sales.

These outcomes mean that you may be able to sleep better at night, but it can mean the same for your funder. Lending is all about risk management and by achieving the above you remove a lot of risk for a project.

Removing this risk will help you get a better funding outcome for your project. This is normally one of two things being price or leverage.

Let’s cover off price firstly. As mentioned above, lending is about managing risks and the better those risks are managed the better price you can achieve on your finance. Primarily this is a result of being able to work with a cheaper funder such as a main bank rather than a typical non-bank lender. This could save you thousands of dollars, in the presentation we did with OPES we showed a project with approx. $5.4M of development costs (excl. finance) and there was approximately $215,000.00 savings by working with a bank over a non-bank lender.

What is also not often picked up is that a bank will also price relative to risk – this is called risk based pricing. You may only need to get to 70% pre-sale cover to get bank finance, however, the more you have the better the bank can price your debt as they are required to hold less capital. Selling down properties worth 120% of the debt you have vastly increases the likelihood of the lender being repaid in full on completion as there is now scope for some contracts to fail.

Next we look at leverage. Again, by selling off plan you are removing risk from the project. In doing so you can allow a lender to increase their level of leverage on a project as their debt repayment becomes more secure. If a lender is more certain about being repaid they will be happy to look at lending more money.

At the greatest extreme this could look like the lender providing finance for the entire project costs meaning you have no equity in the transaction. This normally means you will be securing an equity release on settlement as likely will have covered off some land acquisition and consent costs, but greatly reduces your capital outlay on a project. Note that this can be costly, however, the benefit is that it may allow you to scale and look at more projects by allowing your capital to be distributed further.

It is important to note, that purely selling down the product off plan is not enough to fully mitigate this risk. You will also need to ensure there is sufficient margin in the project. Lenders want to see the developer making a good profit and there to be headroom above their lending limit.

Who are the best buyers?

This is an interesting question as there isn’t really a right answer here, however, we will seek to talk about some options and what their advantages and disadvantages may be.

Kainga Ora (KO or Housing New Zealand).

This is effectively the New Zealand government. As has been well advertised, New Zealand has a housing shortage and a great focus of the government over the last 5+ years has been about addressing this through delivery and acquisition of properties throughout New Zealand.

Looking at KO being a purchaser of your property the great advantage is around the exceptionally low risk of default. Given KO is backed by the New Zealand government the likelihood that they are not able to proceed with the purchase on completion is near zero. This is great as it vastly reduces risk allowing for better pricing and leverage.

It is also well documented that they may offer above market rates for certain properties in certain locations, though this can present its own challenges when arranging funding.

Lastly, given the use of the housing they tend to be relatively relaxed around specifications (appliances etc) which can mean cheaper build rates.

The downside of dealing with Kainga Ora, however, relates to a few things.

1. It can be a drawn out process to secure the contract. As we are all aware, government agencies don’t tend to be the quickest or most efficient and this can mean a prolonged period to secure your sale.
2. They are very specific around their requirements. KO have specific design and location requirements which can be prohibitive to a developer. This includes the minimum sizes for building footprints / rooms, parking requirements, locations (most city centres are difficult to get contracts in, there is a great focus on regional locations), access to public transport, concentration of public housing in the area and much more. This can mean that a project is less profitable or unworkable based on design requirements.
3. Particulars to their contracts. KO are for the most part cooperative with developers, however, it is important to note that they put a great focus on key dates within their contract. This may seem onerous, however, if you step back and look at the planning they put into housing people understanding when properties will be delivered is crucial.

We typically find KO are a great prospect for more regional developments but not for everyone. Something to consider early, however.

Home Buyers

This is people purchasing for their own home. Again, there are some great advantages here but also some difficulties. Let’s look at the advantages first.

A home buyer is considered a lower risk of default from a lenders perspective. Because this is an emotional decision and likely one of the most significant financial events for the purchaser lenders consider that they are far less likely to default and will do a lot more to complete the purchase rather than walk away from their deposit.

If you are targeting first home buyers as well there are several grants and avenues of financial support to assist this group with acquiring a home which can mean it is easier for them to get the finance required for the purchase.

Lastly, because this is a home for them to live in they can be a little more agnostic around price meaning you may be able to achieve a better price point and therefore better margin on the product. Home buyers tend to be more emotively driven.

Now for the disadvantages.

Home buyers can be picky. Given they are purchasing this home to live in themselves they may seek variations such as upgraded appliances, changes to the fixtures and fittings or other items to make the property more ‘liveable’. Whilst you may be able to price this it can be niggly to manage through the development process causing time delays and impairing some efficiencies.

Home buyers are also more likely to be responsive to current market conditions. What I mean by this is that while the market is a bit tougher with climbing or high rates or there are stories about building companies failing they can be gunshy about buying off the plans and seek the certainty of existing properties. This can make them harder sales to secure and therefore a slower sale process.

Investors

Investors for a large part are inverse of a home buyer. They will be less picky around the minor pieces of the property focussing more on cost and durability. Often simple product is the best meaning cost efficiencies when building.

They also will be more willing to look through a property cycle and make a commitment to purchasing, in fact, sometimes they will see market conditions like today as a great opportunity to purchase off the plans with the view that they will improve before settlement.

Those are some of the advantages.

The disadvantages centre around the fact investors are likely to do a lot of research concerning value and location to ensure that they are purchasing a great investment. This can mean that you will need to be competitive in price and build in the right locations. If you don’t do your research up front you may end up building a product people don’t want to hold as an investment and find it difficult to sell.

Investors are also seen as more business like buyers, which for a lender can translate to a risk that they will walk away from their deposits if things were to go wrong. For this reason, rightly or wrongly, lenders will often look at sales to investors as more risky than those to home buyers. That isn’t the end of the world as lenders are still more comfortable with a sale than without, but something to consider.

What to look out for in a pre-sale contract

So now that you are convinced to sell off the plans we had better speak a bit about the pre-sale contracts and key points to understand with these. A pre-sale contract is an agreement to purchase a property at a point in the future when it is completed. Because it is a future commitment there is an element of uncertainty. Some of this may be addressed and it is required to ensure you have a ‘qualifying pre-sale’ for the funder. To that end there are some key items to account for when putting this together;

1. Deposit Amount: this is the deposit that the purchaser will pay you to secure the purchase. It can be tempting to offer a lower deposit to tempt buyers to commit to purchasing off the plans. This is not acceptable to funders, they will seek a minimum of a 10% deposit for any purchaser and in instances where the party is overseas this could be 20%+.
2. Sunset Dates: perhaps the most contentious issue we see on pre-sale agreements relates to the sunset date. A lender will typically require these to be no less than 12 months following expected completion. It is therefore important to take into consideration your build programme, perhaps consenting and some contingency when setting this date in your agreement.
   We also see some developers include a right to extend the sunset date by a further 6 months within their agreement. This is a handy mechanism to have in place to account for any delays in project commencement or programme.
3. Arms Length: part of the benefit of a a pre-sale is that it gives an indication to the funder of the market acceptance of the product and value as mentioned earlier. To that end they require these to be arms length (I.e. not to a related party) to ensure that it is an accurate representation of the market.
4. Substitution Clauses: this was in particular focus in late 2020 and early 2021 as we faced enormous supply constraints in the market, particularly with gib and weather board. A substitution clause in your agreement will allow the developer to use different materials as a substitute to those specified if for any reason the proposed materials cannot be sourced. This is important as can have a great effect on any potential delays in programme which can put loan terms and sunset dates at risk.
5. Personal guarantees: often investors will purchase investment properties under an investment vehicle like a company. This may mean the company is signed up as the purchaser or is the nominee. In this situation a guarantee clause will allow you to secure a personal guarantee from the primary stakeholders in the investment vehicle giving you an avenue of recourse if the sale falls over.
6. Vendor conditional dates: another consideration for developers if they require a certain amount of sales to proceed with finance is having a vendor finance condition or similar in their agreement which allows them to cancel the agreements if they cannot secure adequate finance or sales to proceed. We recently saw Ockham put a project on hold and return deposits to purchasers, this would have been via a similar clause that allowed them to do that.
7. When is your commission payable: This would be more often found in your agency agreement rather than sale and purchase agreement, however, it is important to understand. Some agents will require some or all your commission to be paid at the date of the agreement going unconditional or your finance date. This is prior to the properties settling and therefore can mean you need to finance possibly hundreds of thousands of real estate commissions from cash flows. Luckily these funds can form part of your finance but you want to be clear on that up front.
8. Power of Attorney Clause (POA clause): This is a clause in the agreement which gives the developer the right to remove (or add) any caveats / encumbrances on the property lodged by a purchaser in the process of securing titles for a development. Again, this is a very important clause as a project can be held up by a disgruntled purchaser who could impede you securing titles for the balance of your settlements at times giving them an overweight negotiation position.

These are just some of the conditions / clauses that we recommend reviewing and discussing with your lawyer when forming a pre-sale agreement. It is by no means an exhaustive list but a good steer on things.

When and how can I get pre-sales?

Convinced and prepared to secure pre-sales you need to now understand when and how to do so.

Firstly to address the when. Technically you can seek pre-sales as early as you like in a project and do not even need to have consents secured. There is, however, some risk associated with this. If you secure sales based on some renders and plans that are unconsented and these change in the consent process you will need to have these approvals agreed by the purchasers. This can be an onerous process and may result in some purchasers cancelling plus time and cost for you.

Also, doing sales this early will mean you will need a very long dated sunset date as you need to account for consenting (4 – 12 months) as well as the construction and delivery of the project. It could mean a 3+ year sunset date.

Typically developers will begin to seek pre-sales post securing their resource consent and after having a finance discussion. This wouldn’t necessarily be a formal finance offer but could be a detailed discussion with their broker or financier to get a steer on what would be required and the funding may look like. Having resource consent secured limits the risk of changes in consenting and the pathway to building consent and beginning construction should be straight forward.

Next, the who. Most agents in New Zealand will offer pre-sale services, however, some are better placed than others. As mentioned above we recently did an event with OPES around pre-selling projects. OPES are a business that sell down projects for developers to investors they work with on planning and managing their property wealth plans.

As we mentioned in that event, at Lateral we really like working with OPES as they have great engagement with their clients (purchasers) and educate them exceptionally well on the navigation and finer points of acquiring property off plans often helping with the sale process. A number of the points we raised above they will cover off with their clients to ensure they can make informed decisions quickly.

OPES also work closely with the buyers right along the delivery process ensuring a very low risk of default come completion. The detail they go into qualifying a client and then hand holding throughout is very well received by lenders.

Outside of OPES, the Bayleys project team have shown a strong ability to sell down projects and have a great market presence. The benefit of one of the name brands (Bayleys, Harcourts, Ray White etc.) is that they have an extensive agent network across New Zealand and you will end with a lot of exposure for your products.

There are some other off-plan specialists that are similar to OPES such as The Property Factory, Staircase, EnableMe, Positive Real Estate, Propellor etc. At Lateral we don’t have a lot to do with these brands so can’t comment in detail but aware they offer a similar service.

If you were looking to sell to Kainga Ora, Lateral work closely with James Radics from Calibre Property who has a strong connection with the organisation and great understanding of their needs and processes. He is very able to secure contracts if required.

If you have a project and are considering pre-sales reach out and we can help point you in the right direction and make the introduction.