Friday, January 20, 2012
Dear Reader,
Developer finance is, as the name suggests, where a developer finances a piece of property you purchase from him. He’s the bank. There are differences between developer finance and bank finance. And there are also subtle differences within the broad category of developer finance.
Developer finance is most common for pre-construction properties. It’s also most common in markets where bank finance is extremely difficult to get for foreign buyers and/or prohibitively expensive. That covers most of the markets on our beat in Central and South America.
Firstly, it’s important to understand that with developer finance you typically don’t own the property until you have made the last payment. The developer doesn’t have to foreclose on you if you stop making your payments. He can simply take the property back –and keep the monies you have paid to date. He probably won’t even have to go to court to do that, either.
That’s why developers will sometimes approve you for finance without a credit check. It’s a bit of a win-win for them. You pay for the property…they are happy. You don’t…they find another buyer, and they keep whatever you have already paid, without having to go to court.
Title to the property is transferred when you make your last finance payment. There can be plusses to deferring the transfer of the property title. In Brazil, because bank finance was almost impossible to get on pre-construction property, and bank finance charged double-digit rates, developers typically finance condo purchases over a longer period of up to ten years. They do this by selling on the income stream (their receivables) that will accrue from these payments. This is starting to become less common now that locals can get mortgages on completed units. That’s why we’ve seen the prices of condos spike once they’ve been delivered: it’s at delivery that locals can get a mortgage.
Delaying the title transfer means that you don’t have to pay transfer taxes and some other closing costs until you close…in up ten years’ time.
I’m familiar with the idea of avoiding closing costs by selling a condo pre-completion. But I haven’t come across a situation like this before where the costs can be kicked so far down the track. Of course these costs could go up during that time period. However, I’ll take a transfer tax bill ten years from now over one today any time!
In some countries, developers may pay back some of the money you have paid on your condo if you stop making finance payments and they take the unit back. But that’s not the norm in Latin America. It all depends on what’s in your contract. So, you should always make sure you understand the terms of your finance deal.
So, what use is developer finance to you?
That depends on a numbers of things.
Firstly, if due to a lack of savings and/or a poor credit history, your only option is developer finance, it’s a straight forward take it or leave it scenario. Developer finance gives you an option to buy.
If you have other options (cash in a CD, shares you can sell or an IRA) you need to consider how much the finance costs. If you are confident you can make 8% from your other investments and the developer wants to charge you 5% you may decide to keep your portfolio intact and take the developer finance.
But if you are only earning 1% on cash deposits in the bank it makes sense to buy using cash rather than pay 5% interest to the developer while your cash earns 1%.
Not paying the developer in full has additional side benefits. Firstly, there’s a risk associated with pre-construction. If a developer disappears or a project goes under, it’s better if you have paid him 20% of the purchase price rather than 100%. Slim consolation I know, but it helps keep your downside risk as low as possible.
If you are worried about inflation you might be happy to pay for your real estate with future dollars. They might be worth less in the future than they are today.
Remember that if you are buying in a foreign currency it could appreciate against your home currency, leaving you with significantly higher outgoings.
But these are turbulent times. So, irrespective of the considerations above if you feel uneasy about having your cash in a bank, or in stocks or bonds, you might not want developer finance. Your property is your bank.
Sometimes developer finance can be a no-brainer. That’s when it’s free.
For example, members of my Real Estate Trend Alert group can buy a lot in Costa Rica’s lake district of Arenal with a 10% down payment and interest- free developer finance for ten years.
The entry price for a lot is only $19,000.
Members can buy with $1,900 down and monthly payments of $143. And it’s stunning in Arenal, where a volcano towers over a huge lake and rich green pastureland. More about that another time…
If we had to borrow $19,000 with an interest rate of 10% our monthly payments on the loan would be $225.98. That’s 60% higher than the $143 a month you pay on the interest-free plan.
Is developer finance right for you?
As with many choices relating to international real estate the answer will come down to your view on the world, how much cash you have…and how comfortable you are with risk.
Ronan McMahon
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