A brief guide to material contracts in property developments
Contracts, not concrete, form the foundation of any solid commercial or residential development. As a developer you should always ensure you have airtight formal contracts to protect yourself and your interests at every stage.
Considering this, it’s essential that you engage a solicitor with specific property development experience early on. We’ve taken a closer look at must-have inclusions in your development’s material contracts.
Sale and purchase agreement for land acquisition
Land acquisition for development isn’t as simple as it seems. It is the critical first step in the development cycle and is a major contributor to the success of a development. It’s important that the contract allows you the flexibility to assess the viability of a development before committing. To allow this your contract should include:
A reasonable due diligence period to allow you to assess the development’s feasibility, suitability of the land for the chosen development, and overall project risks.
Conditioning an agreement on obtaining finance and land use consents to significantly de-risk the project.
A deferred settlement date will allow you to progress the pre-development work prior to having to invest your valuable capital.
Pre-settlement site access to allow consultants to commence pre-development work.
Nick Turner, Director Fortis Capital, says this stage is about mitigating as much risk as possible before taking possession and outlaying capital:
“Ideally, if it can be shown that there has been reasonable value-add since entering into the contract and it is supported by a recent valuation prepared by a registered valuer, lenders will generally recognise the uplift in value and provide additional debt leveraging capacity.”
Sale and purchase agreement when selling units off the plans (pre-sales)
The sale and purchase agreement when selling off the plans is a very important contract as it locks in the loan repayment source, while chrystalising the revenue line. This is particularly critical where the profit margin is tight, but development costs are not locked in, as any cost escalations can quickly erode your profit.
Key contract points to consider when pre-selling include:
A reasonable deposit of no less than 10% for New Zealand purchasers to mitigate settlement risk and offshore purchaser’s deposits should be no less than 20% due to limited vendor recourse against purchaser defaults.
A sunset date provides both vendor and purchaser the ability to cancel a contract in the situation where a sunset date is reached. Most lenders will require sunset dates to be no less than 12 months from the expected issuance of code of compliance and titles, to provide a reasonable buffer for project delays.
Importantly, a contract should provide personal liability back to an individual, to provide the vendor with recourse in the event the purchaser defaults. It is also important that both parties to the contract are clear on the product specifications to reduce the potential for disagreements at the time of settlement. This is generally achieved by way of an addendum to the contract which provides a full-spec description of the completed product.
A finance clause can also be included for the benefit of the vendor, and settlement should be a maximum of five days from issuance of practical completion and title issuance. Purchase prices should be at or above valuation as your lender will be relying on the valuation as a backstop where a presale contract falls over. Turner adds that good purchaser due diligence is also important as both vendor and lender rely on their ability to settle:
“It’s preferable not to sell all units to a single party as selling to a range of different purchasers spreads the risk of purchasers defaulting. Typically, prime lenders will only recognise a maximum of two presales to any one party as “qualifying” presales where non-bank lenders can take a more pragmatic approach.”
Agreement to lease on completion
When pre-leasing to commercial tenants upon completion, the lease agreements can be quite complex, especially if you’re not familiar with them, so take the time to ensure the terms are favourable for you.
Preferably your lease should be net (not gross), which allows for the bulk of the OPEX costs to be passed on to the tenants. The lease should also include a description of the property being leased including location and square meterage, as well as lease term, frequency of rental review dates, and any rights of renewal.
Make sure you understand your responsibilities as landlord and always consider how a lender would view the commercial terms of the lease agreement.
Construction contract between the builder and developer
Another important contract in any development (and where many developments often go wrong) is the contract between the developer and the builder. The two most common build contracts are the NZ3910 contract and the Master Builders contract. The former contract is generally more suited to larger commercial projects, whereas the latter is for smaller projects. Build contracts should include a fixed price lump sum contract price, the expected start / completion date, payment terms, builders contract works / public liability insurance and a defined defects liability period. The most common payment terms are progressive payments, staged payments and charge-up.
Importantly it should also include retentions which is an agreed percentage of the amount owing to the builder withheld from each payment. This provides a form of security against the builder so that they are motivated to fulfil their obligations under the contract. Liquidated damages and performance bonds should also be considered, says Turner:
“A performance bond is usually issued by the builder’s bank in favour of the developer and is assigned to the lender. The bond is typically 5% of the contract value and can be called upon in the event of a material breach in contract by the builder due to insolvency, abandonment or complete non-performance. Non-bank lenders generally take a pragmatic view to such a development control.”
Whatever shape your contract takes, it's essential that your lender verifies it before you sign to ensure that it meets their requirements - and that it’s prepared by a solicitor with the requisite skills and experience.
Are you ready to start planning your development?
Get in touch with the property finance experts here at Fortis Capital for finance and advice. We are property people with development experience and first-hand knowledge of the process - here to make your vision possible.
*Information in this article is general only and should not be considered advice. Before you enter into any contracts you should seek advice from a legal professional tailored to your unique situation.