There’s a financing model for condo development emerging that holds a lot of promise in a capital-constrained environment, but it’s also fraught with danger for the inexperienced buyer.
I discussed the “super-deposit” model with two industry experts during the Aug. 29, 2013, show, and they had a lot of wisdom to share.
Without pre-sale or construction financing being available, “super-deposits” by would-be buyers allow a development to move forward. It’s a great solution as long as the market stays healthy and you’re dealing with strong developers, says Andrew C. Hall, Managing Partner at Hall, Lamb and Hall, P.A.
But Hall agrees with me that buyers are taking a risk with less well-heeled developers. They’re, in essence, becoming an unsecured creditor. If the market shifts and the developer goes bust, there’s probably no remedy.
“You’re going to turn around and say, ‘How did I get here?’ The truth of the matter is you got here because you didn’t understand what you were doing,” Hall says.
Hall even likens the model to a Ponzi scheme, and he says the temptation is high for a developer to help himself to the profits early.
And forget about trying to negotiate special protections with the developer. On small to medium-sized projects (100 to 150 units), it won’t happen, Hall says. A cookie-cutter contract is all you’ll get.
Without an institutional lender in place, there’s no one to hold the developer accountable for the quality of the final product, Hall adds. If he gets into trouble and starts cutting corners, you could be forced to close on something you’d rather not own.
So, how do you protect yourself? One solution for a high net-worth buyer could be to take an equity stake in the development company itself, then convert that interest into the unit when it is complete. Another is to buy a few units, rather than just one. Basically, you want to create an avenue of recourse for yourself.
Also, stick to buying from quality developers who have a solid track record of performance, says Inigo Ardid, who specializes in development for Key International. With bank lenders now largely absent from condo development, you can be reasonably sure that any deals that are getting done have a solid financial foundation, he says.
Remember, anything can happen in this type of financing arrangement. Read your contracts carefully. You may decide the best defense is avoiding the situation altogether.