What is a qualifying pre-sale?

Presales are a great way to take risk off the table for a developer and allow a project to become fundable in the eyes of a lender. However, not all presales are equal, so it is important not to get too eager to get a sale away, that the strength of the contract is compromised.

Often, we see developers come to us saying they have a good level of presales in place only to find that they are not ‘qualifying’ as per lender criteria. We regularly hear that agents have offered 5% deposits to entice potential buyers without thinking (or possibly caring) about the ramifications it will have to development funding. Remember, when it comes to getting a project off the ground, a developer is normally at the mercy of the lender and should always have their perspective in mind.

What is required for a ‘qualifying’ pre-sale?

Deposit amount – A lender will require a minimum of 10% deposit to be paid and held in trust. In some scenarios (such as overseas) a 20% deposit will be required.

Sunset dates – A sunset date is the date at which the purchaser has the right to cancel the contract if the project has not been completed. In today’s building environment with delays commonplace, lenders are looking for sunset dates of 12+ months post expected practical completion of the project.

Substitution clause – This allows the substitution of materials during construction. It is important particularly in the current environment, as if there are delays or shortages of materials, this ensures the project continues and is completed on time.

Power of Attorney clause – This allows the vendor on, or prior to settlement, the authority to remove caveats and register encumbrances on the title in order to facilitate settlement.

Personal guarantees – When purchasing under a company, personal guarantees are required from all purchasers.

Further to the above, sales must also adhere to the following:

• The purchaser must be arm’s length (i.e. not a related party)
• The contract must be unconditional
• A single buyer can only purchase 2-3 units in the development. Bulk purchases are not often acceptable as it raises risk on settlement-if that purchaser pulls out, then the project is put in jeopardy.
• Pre-sales cannot be cancelled or rescinded without the bank’s written consent
• Pre-sales cannot be assigned without the banks written consent

Beyond the contracts, selling down to home buyers over investors (or a combination thereof) can be important as well. Normally in a property cycle, investors are seen as the riskier purchasers, as they are more willing to walk away from a deposit than a home buyer. However, in today’s environment you might not have the luxury of being too picky about who your buyer is!

Common pitfalls

The most common and most important mistakes we see are around the deposit amount and sunset dates.

A higher deposit amount means the likelihood of the purchaser walking away from the sale is reduced. If come settlement time the value of the property has fallen by $100k, and the purchaser has paid a deposit of $50k, they are less likely to settle than the purchaser who has paid a $100k deposit.

Likewise, if sunset dates are set at three months post expected completion, a lender will not feel comfortable knowing if the project is delayed, the sale could easily fall over. With the current material shortages and slow councils, programmes can easily be delayed 6+ months. Therefore, having a 12-month buffer puts the lender at ease.

To sum up

If the pre-sale does not include some of the above clauses, how it is treated will depend on the lender. A main bank will take a more hard-line approach, and may not be able to stray far from bank policy. A non-bank or private lender will look at things more logically, and whilst they would feel more comfortable with a 10% deposit and good sunset dates etc. they will still give some weighting to the sale regardless.

It's always a good idea to check that your contracts will satisfy lender criteria. It can prove very difficult to negotiate something after someone has signed a contract. If you need help understanding lender criteria and whether your project meets it, get in touch with us here, we’re happy to help!