The existing property development project doesn’t work in its current structure, but there is an opportunity to make it work if ownership is restructured. The intention is to keep the design, consents and construction works predominantly as-is, complete only what is absolutely necessary and restructure future ownership. Here are some examples of restructuring projects:[1]
- Convert sales into leasing. Assume a 100-unit condominium project has contracted sale prices that do not cover the cost to complete construction. The lender now controls the project and you have been brought in to assess how to resurrect it through restructure. Selling a half-completed project will mean a substantial loss to the lender so they are prepared to work it through. The condominium market has deteriorated below original list prices so there is no opportunity to ask buyers for more money. All contracts will need to be terminated. However, there is no point trying a new marketing campaign to sell condos as market prices do not support the remaining construction costs. The best course of action you determine (at least the lesser hit to the lender’s wallet) is to complete the project and lease the units in the rental market. You would continue to rent until the ‘for sale’ market appreciates, and you can sell down units or until a suitable long-term investor is found to purchase the completed development. Taking it further down the ‘for rent’ spectrum would be a conversion into short stay serviced apartments.
- Convert leasing into sales. Typically, this type of restructure occurs mid-cycle in an appreciating residential real estate market.[2] As the market improves, yields generated by for rent units generally get surpassed by the effective yields home buyers are prepared to pay. The arbitrage gap allows a developer to purchase a block of residential units at say 10% yield, undertake cosmetic renovations, create separate ownership titles and sell to individual buyers at an effective 5% yield.
To illustrate, assume a 10-unit apartment project, when complete, is worth $5,000,000 with a gross rental of $500,000 (10% yield). Unfortunately, the ‘for-rent’ developer has defaulted on the loan and you are looking to purchase the half-finished opportunity from the bank. You determine that if you restructure future ownership to individual home buyers, they will pay $750,000 per unit. The total income you receive is $7,500,000. The rental remains at $500,000 but dividing it by the for-sale price represents an effective yield of 6.67%. There are costs — $500,000 in legal, utility separation, marketing and some redesign. But you have created two million dollars by magic!
Another example is converting a for-lease building to for-sale office, retail or industrial condominiums. Rather than continuing to try and lease a large space you sell off individual units (like floors or adjacent spaces). This restructure is viable when the market to smaller investors and owner operators is superior to the general leasing market or selling to larger investors.
- Sales or leasing into hold. Selling the project is only feasible with a heavy discount. Leasing it on completion carries too higher operating cost and low rentals and detracts from a more profitable use in the future. In this case you complete construction to a certain point and restructure to hold until a better time to sell or lease eventuates. An example is where you have created a residential subdivision but take the sections off the market and move it from an expensive debt leveraged position to a long-term hold and equity position. Or it may be farmland originally to be developed, where the market has changed, and you decide to continue to hold as farmland. Or it might be leaving the expensive internal fitout of the penthouse in an apartment building unfinished until the market improves.
[1] You see restructures all the time post the peak of a market cycle.
[2] Americans know all about the condo-conversion craze!
Restart #1: Intro
Restart #2: Continue As-Is
Restart #3: Clean Up and Dump
Restart #4 Renegotiate and Continue
Restart #5: Clean Slate and Continue
Restart #6: Consolidate and Segment
Restart #7: Restructure Existing
Restart #8: Reposition
Restart #9: Replan
Andrew Crosby
+64 21 982 444
andrew@xpectproperty.com
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