Property Development: Forward Selling
By Qandor member Dorian Payne, co-founder of Castell Group, a property development company that has 170 homes in the pipeline. In this article, he talks about the advantages of forward selling.
Have you considered focusing on forward selling your developments? All property developers can make money in rising markets; errors or omissions typically get masked by the rising value throughout the build. What happens if the market stagnates or declines?
This happened to me a few years ago when I was developing for open market. It was only a small development site, but I made several mistakes which are very common for developers, especially when rushing or underestimating the market risk. Below are some of the key mistakes I made.
Appraisal wasn’t thorough enough (High-level figures only).
Assumptions used in the appraisal weren’t verified.
Sale values and demand (exit) were too bullish.
Underestimated the market risk / lacked sensitivity analysis to quantify what would happen if sales were delayed.
Didn’t actually understand my own risk profile or appetite.
Thankfully the site sold and was only a few months behind, but it opened my eyes into what could go wrong and re-focused my attention on de-risking.
Keeping it basic, there are a few key elements that can turn a profitable project into a loss-making disaster.
Underachieve on sale price;
Delay (build or exit);
Overspend on build.
I highly recommend any sensitivity analysis at the appraisal stage takes these into consideration to ensure you are comfortable with the risk as the developer.
Forward Selling:
The first two risks could be mitigated through forward selling, which means pre-selling the finished unit / project to an end-buyer prior to commencement. The sales price is agreed upon, and in theory there shouldn’t be a delay on the exit. It allows the developer to focus on the pre-construction, delivery and handover stages which a competent developer can control to a certain degree. As a caveat, property development can throw up unidentified issues at many points and requires consistent focus and good processes and a skilled team to deliver successfully.
A developer could look to forward sell to the following:
Registered Social Landlords (RSL) – This is what we focus on by building affordable, social and disabled housing.
Local Authorities (L.A.) – They are now able to borrow moneys to deliver more affordable housing.
Larger Investors – Developments which are purpose-built for larger or institutional investors, such as larger student housing or supported living accommodation.
Businesses – Expanding businesses are consistently looking for purpose-built commercial buildings to either buy or rent.
Off-plan to smaller investors or general public - Investing in up-front marketing to try and sell off-plan could help reduce the risk by agreeing on the sales price on schemes intended for the open market.
Some positives of forward selling are:
Secured exit;
No delays on completion;
Potential ability to develop unviable sites;
Pre-agreed specification;
Scalability;
Potentially lower risk.
There are also some negatives to consider:
Can be a slow and tedious process drafting the contracts;
Additional upfront scrutiny;
Buyers can be demanding;
Buyers can become insolvent;
Possible retentions, bonds and guarantees;
Possible defect liability periods;
Could be reliant on public resources (RSL/L.A.).
It can work well and help a developer to de-risk. As with most things in property development, each deal will have its own intricacies and each buyer will have their own requirements which may be onerous or render the project unviable. Even though there’ll be an exchanged conditional sale contract, buyers should also be vetted as there will still be an exit risk.
The above article is not intended to be a complete and thorough guide to forward selling; instead, it’s intended to provide property developers with a high-level perspective of another route they can consider.
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