Every year a significant amount of new home transactions are pre-sales. This is especially true in the multi-unit markets around our provinces’ urban centres. Pre-selling gives developers a level of revenue certainty, gives banks comfort that the product has committed buyers and from that, allows construction financing to flow once agreed-upon sales targets are achieved. Pre-selling a significant amount of the total units has become a standard practice in our market.
Prior to 2005, all funds received as deposits for purchases of homes had to be held in trust until the project was completed and the unit was delivered to the new homeowner. Millions of dollars sat idly in trust accounts for years while projects came out of the ground and were eventually completed.
What changed on January 1, 2005, were sweeping changes to the Real Estate and Development Marketing Act. The changes allowed developers to now use those pre-sale deposit funds to pay for direct project costs for the projects themselves. This was a landmark change and allowed all that hard-earned capital to be put to work building the project it was earmarked to buy. Not only did these changes make sense, but they were also embraced by the industry.
Despite the obvious benefits to the developer, uptake on the product was slow at first. It took some time for all stakeholders to become familiar with and comfortable with this new form of project financing. There was a learning curve. Now we can say, deposit protection insurance (DPI) is mainstream; it is a box to be checked for most brokers arranging the capital stack for their developer clients.
For the developer, the economic benefits are compelling. They will save the spread between the annual premium rate of the DPI and the costs of capital of the debt replaced by the deposits. The savings are significant and are there every year until project completion and the unit turned over to the homeowner. For the banks, the credit ratios are improved and some projects on the line may move forward with the improved financial metrics.
To apply, it is recommended the developer use an experienced broker to assist in putting together the information. The information itself is fairly straightforward with most of it mirroring what the developer has already provided to the primary lender. This along with a questionnaire and construction lending agreement are generally what is required to move forward. The underwriting process of DPI follows a similar path to that of the other lender(s).
This includes reviewing the viability of the project from a financial perspective. Examining the overall budget and proforma’s, along with key credit metrics, are important in determining the financial wherewithal of a project. This is done in conjunction with reviewing the developers overall financial strength and project experience.
The development team is an important factor when a project is reviewed for DPI. This includes: project lenders, general contractor, subtrades, architect, consultants (structural, geotechnical, building envelope, mechanical, electrical), lawyer, marketing firm, mortgage and insurance brokers. A strong development team assists in mitigating the challenges that arise on projects. This provide stakeholders with an increased level of confidence that solutions are found swiftly and implemented effectively.
As with all forms of construction, issues can arise during the different stages of the building process. The construction approach to that risk is assessed at the outset. This includes the developer’s project experience and key staff if they’re self-performing. If an arm’s-length general contractor or construction manager is hired, the merits of the form of contract are considered (fixed price vs construction management). Subtrade risk is an important factor, as the quality of subtrades can have a substantial impact on a project and its schedule. Contract performance risk and subtrade payment risk can be further mitigated and managed through construction bonding. Performance and Labor & Material’s bonds are an important tool developers can utilize to manage construction risk and control major cost components.
Your broker’s experience is important through the underwriting phase and ultimately in the Facility Agreement you ink with the DPI provider. Some of the key aspects of your facility are the security provided, the premium charged and the deposit release terms. The earlier funds are released, the sooner economic benefits are realized and for a longer period. Once terms are agreed upon and finalized, security is then drafted up in conjunction with the lenders in the capital stack. When the security is finalized funds can then flow into the project according to the agreed-upon release terms.
The savings are substantial and the product has evolved into an important and mainstream component of development financing. It’s a competitive and dynamic market out there and your broker will guide you through the process and ensure you get the best deal.
The views expressed in this article are exclusively those of the author; they do not necessarily reflect the views of Trisura Guarantee Insurance Company, its affiliates or partners.