The Hidden Traps in Residual Stock Loans

As a developer, finishing a property development successfully can be challenging enough, so choosing the wrong loan at the end can drain your profits.

It's, therefore, vital to consider how the construction loan will be repaid once the project is completed. If you have sufficient sales to pay off the debt, that's an excellent outcome. However, the reality is that most projects need to be in a different position, whether due to market conditions or developer intentions. Therefore, residual stock loans, which are loans against completed property used to settle a construction loan, are integral to a developer's finance repertoire. Here are some factors to consider when seeking a residual stock loan:

Are You Selling Down or Holding?

The ideal residual stock facility will hinge on your plans for the remaining units. Adopting a holding strategy makes a lower interest rate and a longer loan term crucial. Conversely, if you're selling down, the flexibility in reducing the balance or payments becomes paramount. A low-interest rate with a minimum term might lead to higher overall costs in this context, so ensure your choice aligns with your circumstances rather than just the rate.

How is the interest calculated?

Not all quoted interest rates are equal; you should also understand the interest calculation method. For instance, is the facility a genuine capitalised interest facility, where you're charged only on the loan's balance, or does the facility deduct the full interest at settlement and charge interest on the entire balance? This distinction can significantly influence the effective interest rate. Consider these two examples of $10m residual stock loans: Example A with true capitalised interest and Example B with interest deducted at settlement.

Example A has a rate of 10% for 12 months – using true capitalised interest calculation, the allowance for 12 months of interest is $947,846, equating to a real rate of 9.47%.

Example B's rate is 9.75% for 12 months – this method deducts the total $975,000 at settlement, resulting in a pricier facility than Example A despite its ostensibly lower rate.

If feasible, monthly interest payments would be more economical than either Example above, as you only pay interest on the initial principal. However, lenders will expect evidence of your capacity to service the loan in this scenario, a hurdle for many developers.

What happens at the end of the loan period?

If you opt for shorter loan terms with a selling intent, you must understand the end-of-term procedures. If sales need to meet expectations, the last thing you'd want is to be urgently refinancing, hastily selling your properties, or facing exorbitant default charges. Before committing to any loan terms, familiarise yourself with potential rollover fees and whether the lender is inclined to extend the term.

Residual stock loans are pivotal in the development journey for many projects. A solid grasp of their workings and potential pitfalls will ensure the project's latter stages stay within the effort put into the construction phase.

Happy Developing!