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Why Investor Pre-Sales May Not Count Toward a Pre-Sale Test?

December 17, 2021

Because investors pose a greater risk of walking away from their obligation to close a pre-sold home, some lenders may not count investor pre-sales when validating a project.

For a residential “for sale” construction project to be viable, a certain number of pre-sales will typically be required in order for a lender to approve a construction loan and advance funds throughout development. The specific “pre-sale test” criteria may vary, but lenders generally need to feel confident that the underwriting value for the project is substantiated by pre-sales in place. Furthermore, the lender also needs to feel comfortable that a) the pre-sales will close and b) the residual loan after the pre-sales close represents a manageable exposure.

Not all pre-sales may be judged equally

In most larger developments, investor purchases make up a portion of the advance sales. Investors – individuals or entities that purchase a unit to either rent or re-sell – buy on the assumption that the market value of the unit will continue to rise.

Because investors are not emotionally attached to the home like everyday homebuyers are, they are more likely to walk away from their obligation to close should market conditions change during the construction process and negatively impact market value. Homeowners, who by contrast are not necessarily looking for short-term profit but are buying their future residence, are far more likely to close upon completion, even if there is some market volatility.

This reality creates a concern for lenders who use pre-sales as a way of evaluating a project, as sales that fall through will not generate the funds the builder needs to meet their construction loan obligations.

How many lenders compensate

In order for a developer to qualify for a construction loan, lenders may require projects with significant investor components to obtain larger deposits from investors (i.e. 10 – 25%) to secure their sale. Alternatively, some lenders may limit the number of investor sales to reduce their reliance on this market segment. Such restrictions can make it more difficult for builders to sell out a development and/or get the funds needed to complete the project.

How MCAP can help

As Canada’s largest mortgage finance company, MCAP is in a position to structure loans to allow for funding to occur on a low pre-sale level. The result is that builders can begin construction without the reliance on investor buyers.