why do RA developers sell pre-construction units at a discount?

Question

Hi all, I am curious on why do RA developers want to sell pre-construction units at a discount?

I understand in some regions, developers must pre-sell a certain percentage of their units before they can start the construction. What about in areas that do not have such requirements. My laymen's guess is that they need the deposit from the pre-sale for the equity portion (usually 25%) of their construction loan? Is that the case? If so theoretically, other than the initial building permit and design soft cost, a developer can utilize the end purchasers' cash for equity and not put in a dime of their own money?

Thank you for your time.

Jay Hinrichs · Answer

yes in my case in the same subdivision they also hold the senior debt on the land that we took out to build the infrastructure so their vertical loans takes out their horizontal loans.. but you have to have sales success to access more than 12 vertical loans.  Again these are how my deals are structured does not mean every lender or builder operates the same way but I suspect its a version of this..  Just like lenders on bigger commerical deals want to see  anchor tenant signed up before they will fund construction.

Patrick K. · Answer

Thank you Jay for the detailed answers, definitely clear things up for me.

If I understand it correctly the bank will consider a pre-sold, still under construction, property "secured", thus willing to continue the loan for further projects?

Jay Hinrichs · Answer

Answer is we dont have to  ..  we get full price.

And the deposit sits in escrow until it closes we dont get an advance..  that would be very foolish of a buyer to do that.

what your getting at is this.

Banks require pre sales to make new loans.. Like my bank will only give me 12 spec loans up front and for every pre sale they will give me another loan so if I want to build and sell 30 homes this year I can spec 12 but need to have at least 10 or more pre sold so i can keep my loans coming  .. this is why builders pre sale  its not a cash flow issue and not sure where they discount prices they may say its a discount but in reality its just what the market will pay at the time.

but its the reverse folks going into contract are finding that 6 to 10 months later the house is worth more than they contracted for and some builders are not honoring the sale or have a wiggle out and are raising the price all of the former are happening .. now with rates changing you may see some more motivation by builders to settle in on pricing and preselling.