Rather than apply an arbitrary percentage, GPS Development Finance (GPS) has always been more in tune with developers, and the market conditions when it comes to pre-sales. We can do this due to our size and ability to quickly adapt to change.
As with most developers, GPS has a risk-based approach.
I am often asked to nominate the GPS pre-sale level. My response is generally a “that depends”. I am more interested in the thought process the developer has undergone. Most times, the developer and GPS are on the same page.
Build price escalation and delay in construction times continues to be a major factor. We live in uncertain times and can’t reliably predict whether build prices will continue at ~1% per month, go higher or stabilize. I think we can all safely rule out any substantial overall reduction.
There is also the issue of where sale prices and volumes will go. Again, we live in uncertain times. Will there a be a recession “we have to have”?
Will the new Federal Government keep up the stimulus payments?
Will global energy and food issues cause stagflation?
Only time will tell.
The bank approach of dept coverage from pre-sales hasn’t adapted to market conditions and they have always failed to apply proper relationship lending. This approach never went away at GPS. The issue is that if there is a substantial escalation in construction costs, there is a reduced level of stock which can be sold for higher prices to recoup the cost. It is naive to expect the builder to bear all build cost increases. They will simply go broke. We have seen too many instances of this in recent times.
In very general numbers, a ~5% increase in construction cost will require a ~10% uplift in sale prices of the residue stock, if there is 65% pre-sold. This reduces to only requiring a ~3% increase in sale prices, if there were no pre-sales.
I believe that the answer lies somewhere in the middle with a ratchet approach. In general terms.
- Pre-selling some of the product to test the marketability. The type of product is relevant particularly if the product is what we term “pioneering”. Make sure there is a market adjustment clause;
- Once construction has commenced and there is more certainty as to the build cost, reprice and sell another portion of the product;
- The next portion can be repriced and sold when construction is nearing completion and there is better certainty as to the build cost; and
- The final portion can then be sold, hopefully at a premium, to the touch and feel segment of the market.
There are many other factors to be taken into account, which include marketing costs at the various stages and sale volumes which will have an impact on interest costs.
The imperative is to monitor the market, and adapt.
Overall, it is all about making an acceptable profit at an acceptable level of risk. A GPS developer once said that “you don’t go broke making a profit”.
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