Buying New Construction

When lenders and developers negotiate development loans, they usually negotiate what is known as the “release price” for each unit in the project.

Depending on the time in the life cycle of the sales effort, all or some of the proceeds from a unit’s sale will either go to repay the developer’s bank loan (and interest on the loan) or will be retained by the developer as profit on the unit. When a lender receives its release price, it releases the lien it has on the unit so that the developer can close the sale and give unencumbered title to the purchaser.

So, developers of new projects are not entirely free to negotiate prices. If the developer goes below the release price he can do so only with the consent of the bank because that revenue is reserved for the bank in exchange for giving a lien release.

Often, in exchange for lowering the release price to attract buyers the bank will extract a price and require that the developer provide either additional equity or interest, bring on additional partners or take out more loans (with resulting interest charges) to cover the bank’s reduced revenue. And in today’s credit environment, interest on additional loans is more expensive as credit has dried up.

The situation becomes even more complicated because banks themselves are under a lot of pressure these days. If a bank’s “capital reserves” (required by government regulation and accounting standards) are insufficient, the banks are restricted in agreeing to lower release prices because their balance sheets could be adversely effected , in turn causing a higher capital reserve to be established. This winds up costing the bank money in one way or another.

It’s all very circular and interconnected. Necessity rather than profit-motive is to some extent dictating the pricing in many new developments.
The dilemma this raises for buyers is that your price negotiation becomes a bit more complicated. You just can’t gage whether price resistance you encounter is because the developer has elected, in his wisdom, to concede no further or, alternatively, whether he’s actually precluded by his bank from being more accommodating and is unable to meet your terms even if he were inclined to do so. If the developer’s wanting to maximize profit is the driving force behind the negotiations, then the more you resist the purchase the more you might be able to squeeze further concessions; if, however, the bank’s requirements are driving the negotiations, then there just are no more concessions to be had.
Given all of that, new development prices declined on average by 14% in the second quarter of ’09 compared with the same quarter last year. The 2009 first-to second quarter price decline averaged 5%. Still, sales fell about 65% year-over-year, not only because of release price restrictions prohibiting developers from meeting the market, but also because purchasers find it hard to obtain financing for new buildings. Mortgage underwriters are loath to finance purchases in buildings with too few sales on record, because of uncertainty as to the building’s financial stability when few sales have occurred.
When negotiating for a unit in a new development be very independent in order to best assure the lowest price you can obtain. At the point where you hit a wall in price negotiation, be creative in asking for concessions other than a reduced price ( e.g., free storage space; sponsor contribution to monthly maintenance charges for a period of time; ask the sponsor what concessions he’d recommend); and be ready to walk if you’re not satisfied with the counter offer. If you do walk, tell the agent that you’re ready to do the deal if the developer can meet (or come close to meeting) your terms. Let them know that you’re open to being contacted if the developer sees his way clear to softening his terms or increasing his concessions and that you’re committed to signing a contract if your demands are met. If the developer is free to lower his price, he just might do so. And even if you don’t get a call don’t be embarrassed to initiate one yourself and ask if the developer has come around.
The bottom line is that in order to test the true bounds of the deal, you must be ready to move on. While this is no different from advice for any purchase ( after all, there are the laws of supply and demand at work), it’s particularly cogent in this market when dealing with new developments which have many units on the market, very few of which are particularly unique so that you need not fear of losing that once –in-a lifetime opportunity. Don’t be afraid to walk. You can always come back. In the end, the option to proceed or not is up to you.