Looking at underwriting my first for sale residential condo project.
I understand that hard deposits (rules can differ state by state) can be used to plug a portion of the cap stack (i.e. to reduce equity). Beyond that nuance, I am reviewing some underwriting models where additional offsets were used, primarily broker sale commissions that were designated to be "deferred costs".
example:
$100MM total project budget
$60M senior construction loan
$20M actual cash equity
$10M hard deposits
$10M deferred costs (sales commissions)
Does the above make sense? I can rationalize using the hard deposits as an equity offset, but deferring sale commissions? Is that "normal" for a condo developer to do and for a lender to accept?
In all of the condo projects that I have done in NYC, broker sales commissions are paid and disbursed at the time of the residential unit transaction closing date, so yes that would make sense.
Thank you. Follow up questions:
Should sales commissions even be included in budget as project cost?
i.e. if the total gross sell out value is, say, $135MM on my $100MM total project cost example, then if commissions are 10% or $13.5M total, then net sale price is really $121.5M.
i.e. why would the $13.5M in sale commission be included in the project budget as a "cost"?
Typically 50% of the sales commissions are paid at contract execution and 50% at closing the completed unit. The full commissions is included in the proforma but only the firs 50% is capitalized in the sources and uses. Keep in mind, the purchaser's deposit source of funds only occurs if you hit your presales. Typically, I'll only include the deposit capital from our presales target e.g. 60% presales. There remaining 40% presales can sometimes be used or is restricted as additional security to the lender, depending on the loan agreement.
Thank you. Using that example, the 50% commissions to be paid at contract signing would then need to be budgeted in the sources and uses. In the example I am currently reviewing, there have already been 33% presales (contracts signed with hard deposits). Goal is to be 50% presold by the time groundbreaking occurs. However, no commissions have yet to be paid. The 50% due at contract signing is being booked as "deferred". I suppose that depending on the agreements with the brokers, this could happen, but realistically, seems odd that no commissions would be actually paid until C of O is completed 24 months from now.
i.e. the contracts already signed with hard deposits should in theory have had the 50% commission paid out at time of contract execution. moving forward, assuming more contracts get signed during the construction phase, the 50% portion of commission would need to be budgeted and paid (likely from the construction loan or deposits being used). the remaining 50% are going to be paid at C of O when the buyers are required to pay the remainder of the purchased price so commission is simply netted out of sales proceeds (versus capitalized cost).
Does the above make sense to assume?
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