- Cyprus Property News Magazine - http://www.news.cyprus-property-buyers.com -

Property Developers: Run Forrest! Run!

Property developersMOST property developers still own a significant number of completed units (a figure of 50,000 unsold holiday homes was reported last October) and banks are putting under pressure to dispose of them as soon as possible.

Developers are overleveraged, and in their majority still own a considerable number of finished units and land. Banks are pressurising them to dispose of these assets as quickly as possible in order to pay back their loans. Developers are pushing back, asking for more time or for loans to be restructured by paying them back over a longer time period.

This article examines the dynamics between these two parties, through a simple mathematical example.

Andreas decides to build a multi-storey building comprising of ten apartments.

He has €200,000 in cash and needs €1,200,000 to buy the land and build the apartments. Andreas goes to a bank and borrows €1,000,000 with an interest of 6.0% per annum (€60,000) and a ‘bullet payment’ in three years (he has to pay back the €1,000,000 in three years and only the interest in the mean time). Andreas plans to sell the apartments for €180,000 each.

In the first year Andreas sells one apartment for €180,000. As he is very prudent, he pays the bank the €60,000 interest and keeps that other €120,000 on the side for the next two interest payments. Then the crisis happens. Andreas doesn’t manage to sell any apartments in years two and three, but he has the money to pay the interest from the sale of that one apartment.

At the end of the third year he goes to the bank and asks for an extension to his loan of €1,000,000. Property prices have now dropped by one third, they are at €120,000, and he has nine apartments to sell (a total potential income of €1,080,000 which is more than enough to cover his loan).

Andreas thinks that at these lower prices he can sell three apartments in the first year and two apartments per year after that. The bank is pushing him to sell all the apartments in a ‘fire sale’ for €108,000 each (a 10% discount). That means a total income of €972,000; €28,000 short of what they are owed. Is the bank crazy? Doesn’t it want its money back?

As things stand, Andreas owes €1,000,000 and has nine apartments. He sells three in the first year, and has an income of €360,000 and owes €60,000 in interest. Thus, he has a balance of €700,000 and six apartments left. He then sells two in the second year, has an income of €240,000 and owes €42,000 in interest (6% on €700,000). Thus, he has a balance of €502,000 and four apartments left. In the third year he sells two apartments, has an income of €240,000 and owes €30,120 in interest (6% on €502,000). Thus, he has a balance of €292,120 and two apartments left. In this final year he sells the last two apartments, has again an income of €240,000 and owes €17,527 in interest (6% on €292,120). Thus, after four years he still owes the bank €69,647 and has no apartments left.

The bank knows that the longer it takes Andreas to sell the apartments, the more interest payments are going to be biting into the amount it receives to pay back his outstanding loan. Thus, the bank wants to ensure that it minimises the amount of losses it has because it runs the risk of Andreas taking even longer to pay back the loan, which in turn means that the shortfall between what the bank is owed and what it will receive could be even greater.

The rate of sale matters almost as much as the price achieved. The bigger the loan and the higher the interest, the more important the rate of sale is. In the current environment where projects are overleveraged and interest rates are running high, the rate of sale becomes paramount.

Why should we care?

Well, the €1,000,000 borrowed by Andreas is the money that you and I deposited at the bank. If the bank doesn’t get its money back, then it won’t have any money to pay us back.

Pavlos Loizou MRICS VRS
Managing Partner
Leaf Research