Condo Sell-out Analysis

[Ken B]

Scenario:

A developer has a stepped deposit requirement for contracts on the condo project he is building. Say 10% at contract, 10% at ground breaking, and 20% at some other point. The contract contains a clause that the developer may use up to 20% of the deposits towards costs of construction.

For the market value upon completion:

• should 20% be deducted from the average contract price per unit as that percentage is sunk in the building rather than sitting in escrow and available for disbursement upon closing, or
• should NPV be calculated using the average contract price in the sell-out analysis with a 20% deduction of total contract price for all units deducted from the DCF conclusion, as, again, those monies are not available for disbursement, or
  
• should the sell-out analysis completely disregard that the developer may utilize 20% of total deposits received towards construction costs and that those funds would not be available to a hypothetical purchaser upon completion whose function would be to simply close contracts?

 

[Meandering]

Scenario:
For the market value upon completion:

should the sell-out analysis completely disregard that the developer may utilize 20% of total deposits received towards construction costs and that those funds would not be available to a hypothetical purchaser upon completion whose function would be to simply close contracts?

At completion,
the distribution of funds during the under-construction phase, has no bearing on the sell out

 

[Ken B]

At completion,
the distribution of funds during the under-construction phase, has no bearing on the sell out

So if each contract was $1.00, but you, the investor, were only going to gross $0.80 on each contract, you would still base the sell out analysis on $1.00 per contract?

 

[Meandering]

So if each contract was $1.00, but you, the investor, were only going to gross $0.80 on each contract, you would still base the sell out analysis on $1.00 per contract?

You confuse the effective date of the value.

Either your value is at the point of sell out,

Or your value is mid construction.

Which is it you seek?

 

[Howard Klahr]

At completion,
the distribution of funds during the under-construction phase, has no bearing on the sell out

This is totally incorrect

You confuse the effective date of the value.

Either your value is at the point of sell out,

Or your value is mid construction.

Which is it you seek?

Actually the date of value is as of an effective date when the report is completed (generally contemporaneous with a current date). That is why the analysis is discounted. The objective is to get to the "as is" value. The "as completed" value approximates the gross retail sell-out less the absorption of the sales net of the associated costs. That would be a prospective value as it occurs in the future.

The contract contains a clause that the developer may use up to 20% of the deposits towards costs of construction.

For the market value upon completion:

The cash flows should be applied as they occur. Just as the construction costs are spread out as disbursements over the construction period, the allocation of the deposit toward construction costs should be applied a revenue during the period that the payment is forecast/scheduled to occur. This is presuming that the 20% allocation of the deposit is entirely non-refundable regardless of whether the transaction is completed or not.

 

[Meandering]

This is totally incorrect


The cash flows should be applied as they occur. Just as the construction costs are spread out as disbursements over the construction period, the allocation of the deposit toward construction costs should be applied a revenue during the period that the payment is forecast/scheduled to occur. This is presuming that the 20% allocation of the deposit is entirely non-refundable regardless of whether the transaction is completed or not.

For market value at sell out Howard?

is 10% market? Or is it 20%? Are the pre-sales discounted and the post construction sales increased?

 

[Howard Klahr]

Are the pre-sales discounted and the post construction sales increased?

That depends on several factors such as the length of the absorption period, the number of total units and what is occuring/expected to occur within the market during the absorption period interval

 

[Meandering]

That depends on several factors such as the length of the absorption period, the number of total units and what is occuring/expected to occur within the market during the absorption period interval

Thank you.

My thoughts exactly.

 

[Gobears81]

If I understand this correctly, I believe that it is the type of issue that is solved by a conversation with the client. They may have a reason for preferring one route over another. Whether it is non-refundable has some bearing on how it is handled. If it is fully refundable, I'd be inclined to simply put the full selling price at the time that the sale is completed, as that is when the rights are transferred. Depending on what the client prefers, what effective date is used, and if it is non-refundable, the deposits could be a time 0 cash flow. Either way, it offers support for absorption and perhaps your discount rate-if 50% of the units are pre-sold and non-refundable deposits are paid, I'd feel a little more confident of its prospects than if it were 5% pre-sold

 

[Ken B]

Scenario:



For the market value upon completion:

• to a hypothetical purchaser upon completion whose function would be to simply close contracts?

That's all we really need to know to discuss the methodology. Assume 100% of units are contracted prior to completion, but closings will take 12 months. Don't get sidetracked by issues not related to whether or not an investor would value based upon 100% contract price or 80% contract price, such as whether or not we need to actually apply a discount rate for a 12-month sell-out period.

Here is why I ask. I am reviewing a report where this adjustment (20% of total contract price for all units) is deducted from the DCF conclusion in which the model utilizes 100% of the contract price in the analysis. The explanation provided is that, upon completion, a hypothetical investor who would simply be responsible for closing contracts would not receive the entire contract price from each sale as 20% of the contract price paid as deposits prior to completion of construction are sunk into the construction of the property rather held in escrow.

I have never seen this methodology before. Four of us with about 100-years combined experience have never seen this methodology before. The appraiser says he has been doing it this way for decades when contracts permit deposits to be used to cover construction costs.

I kind of understand the reasoning behind the methodology. I'm just trying to see if anyone else has seen this or has reasoned thoughts on it one way or the other. Does the methodology provide a net realizable value or market value indication?