The Power of an Inventory Loan
An inventory loan can be one of the most powerful financing tools available to a developer. Typically, an inventory loan refers to a mortgage loan secured against newly completed vacant properties, be it residential condominium units, single-family dwellings or commercial units. Accessing capital from these properties, which otherwise sit idle, provides the owner with benefits both to the current development and to the next one.
Get the Best Price
Marketing a property for sale doesn’t always go as planned. Sales absorption can be less than forecast, and the resulting need for cash can pressure a developer to lower the asking price, resulting in a lower profit for the project. Accessing capital from these units can provide the developer with the needed time, putting them into the driver’s seat of a sales negotiation, increasing the probability of getting the sales price the developer is seeking. This has the knock-on effect of setting a comparable value for future unit sales, increasing the value of the entire project.
Keeping New Units New
As a developer reaches the need for cash to fund a project with slow sales, many turn to renting units. While this has many advantages if that is the developer’s long-term plan, doing so for a short-term cash injection likely creates more negatives than positives. Buyers seek brand new units and pay a premium for them, often in the tens of thousands of dollars range. The rental income achieved during the marketing period doesn’t make up for this loss. Now that the unit isn’t new, not only does the developer lose the ‘brand new’ premium, it now has the uphill battle of selling less desirable units, possibly with signs of wear-and-tear. Lastly, converting a unit from inventory to a rental will trigger a sales tax event, further weakening the supposed cash advantage of renting.
On to the Next Project
Completing a project is a momentous occasion for a developer, however in the eyes of your bank lender, the project is not complete until their loan is paid out. That construction loan, which may be reduced in balance by 95% at this point, still affects a developer’s ability to focus the bank on the next project for two reasons. Firstly, in the eyes of the bank’s credit department, there is binary thinking that until the loan balance is zero the bank has exposure to two projects, something that may trigger a decline on the new development. Secondly, account managers have limited bandwidth and may struggle to put the new project’s best foot forward, while simultaneously administering discharges and other daily activities of the existing project.
Focus on Volume, Not Just Margins
Get a head start on your next project by securing land, starting site works, reports, marketing and rezoning. Good opportunities aren’t available every day, so when they present themselves, a developer needs to have capital available to seize on them. The increased financing costs associated with an inventory loan, which can provide the needed capital, will be soon converted into profit. Having projects overlap also increases a developer’s annual sales volume, as new units will be available for sale sooner than otherwise, increasing overall profitability, potentially even with a slight reduction in per project margin.
Raising equity isn’t cheap; well, unless it comes from an inventory loan on your previous project. Raising equity in the traditional method of speaking with investors, costs a developer both time and profit in the form of either project ownership dilution or an expensive interest rate. Having the ability to raise the needed equity from your own sources solves both of these downsides. Raising the most equity you can also positions a developer to attract the best possible debt financing. Lenders reward these lower risk projects with lower interest rates, more attractive presale requirements, and partial discharge terms.
Inventory loans can be used to maintain the value in a developer’s existing project, to seize on the next opportunity and to keep costs in check while doing so.