Developers Substituting Costly Construction Loans with Deposit Bonds Boost Profits into the Millions
The national development boom of the past decade owes much of its high rise to its stunted companion – interest rates. As the economy shifts and rates with it, will financing costs begin to stunt returns instead?
Undoubtedly, yes, as higher costs squeeze margins thus making projects risker or perhaps non-starters.
A lucrative time for developers, low cost construction loans and mortgages have fueled development and property purchases across the country. It’s truly been a seller’s market with condo demand outpacing supply for several years, steadily placing upward pressure on pricing. However, balance is returning to the market having reached peak pricing in 2018.
Pricing is trending downward, and the buyer pool is shrinking making it a less desirable environment for developers with new supply coming online. Add to the mix costlier construction financing and this stirs up a concoction that may potentially erode profit margins. We were shocked in learning of several clients paying as high as 12%!
What’s the answer?
Typical approaches are too tightly manage cash flow and reduce costs wherever possible. Now, some developers are rethinking methods to go about this using technology and savvy financial structuring.
Enter the surety bond, specifically the escrow deposit bond. A debt financing instrument that costs 2%.
Essentially an unsecured credit extension, surety bond mechanics resemble banking therefore act as a financial structuring tool. This specific surety product, the escrow deposit bond also known as an escrow release bond, enables condominium developers to utilize ‘sidelined’ security deposits collected from unit presales as a source of financing.
Security deposits are converted to cash and substituted with an A-rated insurance backed bond, allowing for cash to replace a portion of an outstanding construction loan. The net effect is a blended rate, or reduction in overall cost of debt via bond rates averaging 2%. The condo purchaser receives added benefit from the warranty and deposit protection provided by insurance paper.
Here’s how $50,000,000 construction loan @ a 6% interest rate stacks up:
A profit bump of over $2 million.
Idle money limits profit potential. The increased cash buffer provided by escrow release bonds provide developers with inexpensive working capital compared to traditional high interest rate construction loans.
Gaining an economic edge without degrading components of the project should be at top of mind. Strategic escrow bond usage can provide that advantage - calculate potential savings here.
After all, in the risk laden world of real estate development - who doesn’t need an extra edge?