Only 10% today, 90% on delivery or nothing at all

Apartment sales promotions across the country. Pay just 51% today and the rest upon delivery; pay 101% and the rest upon delivery; get an interest-free loan from the developer, and more. In this article, I’ll try to show you which offers are gold and which might turn out to be lead that will drag you down.

A little background

Given the state of war, the tension, the widespread reserve duty, and the general mood, it’s harder to sell apartments in Israel. In the resale market, things are simple. If you’re having trouble selling at price X, you either sell at X minus 10%, 20%, or you postpone the sale. In the market for new apartments, particularly those from developers, the situation is much more complex. A few words about how an entrepreneur builds a building. When a developer builds a building, they need a financing entity. For convenience, we will call this entity a bank, although other entities are also involved in this field. The bank serves the developer for two purposes:

1. Credit granting The entrepreneur does not have enough money to build the entire project out of pocket and therefore requests credit from the bank.
2. Bank Guarantee – Apartment buyers want to secure their money, so they request a bank guarantee for the money they pay to the contractor. This is The lending bank The guarantor assures that in case the developer goes bankrupt, the buyers will receive their money back or the lending bank will bring another contractor to complete the construction.

The bank's funds provided to the entrepreneur contain two risks. The risk of loan non-repayment, which is familiar to anyone who has ever taken out a loan, and the risk of construction not being completed, which would require the guarantee to be realized. For the bank to enter into a project with the contractor, it examines the contractor and the project and decides that the payment (interest and payment for the guarantee) from the contractor justifies entering the project.

A commercial loan is different from a regular loan that an individual takes from a bank. If I come to take a mortgage, a car loan, or any other loan, the bank examines my income, my conduct, and makes a decision whether to grant the loan or not. As soon as the loan is granted and I pay it regularly The bank has nothing to say about my conduct.. I can pay in installments, go into overdraft (if they allow me), buy a Tesla for 250,000 even if my income is 10,000, and do whatever foolishness comes to mind. As long as the loan is paid, the bank doesn't contact me at all.

A commercial loan is structured differently. The bank assesses the entrepreneur, but the loan agreement specifies not only the loan interest and repayment terms, but also various restrictions that the borrower must adhere to throughout the loan period, regardless of whether they are repaying the loan on schedule or not. Here, we must become familiar with a new concept from the world of construction – Zero report. In business, a profit and loss statement is sold. Report Profit and loss Describing business activity that happened in the past – How much revenue did the activity generate, how much were the expenses, and ultimately what was the profit from the activity. The "zero report," with its strange name, is a type of profit and loss statement for a real estate project, but it is a profit and loss statement. Future. A team of appraisers and economists looks at the construction plans, the cost of the land, the cost of construction according to the plans, and finally estimates how much an apartment will sell for. In other words, a zero report shows what the profit is. The expected From the project. The bank that is supposed to finance the project with a loan and guarantee the buyers" funds reviews the feasibility study and decides, based on the expected profitability and various other parameters, whether to enter into a partnership of some kind with the contractor. Typically, a profitability of at least 15% must be demonstrated. Let’s assume the project consists of 50 apartments, each intended to be sold for 3 million shekels. That means the project’s value is 50 × 3 million = 150 million. Let’s assume that out of the 150 million, the bank provided a loan of 100 million. The bank does not simply release the developer with the loan and wait for payments as it would with a loan to a private client; rather, the loan agreement includes, in addition to interest and payment terms, various business conditions (covenants). For example:

• Sale of X apartments per quarter.
• The cost of building a floor will not exceed Y shekels.
• Prohibition of exceeding the profitability stated in the zero report by more than A percent.
• And other terms as the banks see fit.

If the developer deviates from these conditions, the bank can demand immediate repayment of the loan. In other words, the bank is not just a lender as in a private home construction project, for example, but is effectively a kind of managing partner to the developer.

The Challenge for Banks

We are in a period of various changes in the real estate market conditions. As stated, fewer buyers are coming to purchase. The laborers fled back to China due to the war. Palestinian laborers are not entering the country. In general, contractors are finding it difficult to meet their commitments, both to clients regarding execution time and to banks regarding meeting business targets. With clients, things are relatively simple; there is agreed compensation for delays. With banks, things are more complex as the bank can remove the developer from the project if it wishes. On the other hand, banks are not blind to the situation and understand that if they initiate proceedings against a large number of developers simultaneously, they will also create a problem for themselves. To deal with these challenges, several interesting things have emerged recently, along with some risk for inexperienced buyers.

Contractor loan

A contractor loan is a type of mortgage on the apartment. The buyer takes out the mortgage, but the contractor pays the interest on the loan for a predetermined period. Let’s say the customer owes the contractor one million shekels. Under normal circumstances, the customer chooses whether to pay the contractor one million shekels today to avoid indexation to the construction input index, or to pay that one million shekels, say, in two years and risk having to add the cost of the index. If the index is, say, 3%, then over two years, this roughly amounts to an additional payment of 3% multiplied by one million multiplied by two years = 60,000 shekels. In the proposal in question, the contractor allows the customer to take out a one-million-shekel loan today, on which only the interest is paid. By the contractor And this way, the client actually saves the index risk, which can be tens of thousands of shekels, as mentioned.

Actually, with this method, all parties benefit. The contractor offers a benefit that is not considered a reduction in the apartment's price and therefore does not reduce its total inventory value. Additionally, the contractor can receive additional money not through further loans, which would generally be more expensive than the mortgage the buyers themselves take out. The bank This allows the contractor to move forward with project completion without exceeding the limits of the original contract. The bank also creates a situation where clients are highly likely to refinance their contractor's loan with them, as refinancing with another bank is much more complicated. The client Received a discount of tens of thousands of shekels.

Pay 10% and 90% in three more years upon delivery

An additional benefit that has become common recently is a very low payment upon signing a contract with the contractor, with the balance due upon delivery of the apartment. Sometimes, even with this type of deal, there is no indexation at all. To whom Do you really intend to get The apartment at the end of construction offers a great advantage compared to the norm. If a family lives in rented housing, the ability to purchase an apartment with a small initial payment, no payments during construction, and no indexation is a significant saving and can also be the difference between being able to purchase or not, for example, when unable to pay a mortgage concurrently with rent.

But—and this is an important "but"—there’s a trend of getting involved in these kinds of deals when people don’t actually have the means to complete the transaction in a few years. Someone might say to herself, “I only have 200,000 shekels, and the apartment costs two million.” I’ll pay 200,000 shekels today, and in three years, before construction is finished, the apartment will definitely be worth more, and then I’ll find a buyer to take my place. Let’s assume the apartment’s price rises by 5% annually. In three years, the apartment will be worth 2 million multiplied by 1.05 to the power of 3 = 2,315,250 shekels. Even if I sell the apartment at a certain discount, that woman thinks, there’s still an easy 300,000 shekels in profit. What about capital gains tax and expenses? Fine, so the profit is “only” 200,000 shekels. Tripling your capital in three years is excellent.

Not so fast...

First, for a buyer to be replaced before construction is completed, the contractor, who is a party to the transaction, must agree. For the contractor, there is an additional burden of paperwork as they signed a deal with one client and suddenly they are receiving money (and demands) from a new client with whom they have no contract. Okay, the contractor is under pressure to sell, as mentioned, and agrees. They even write in the contract that they agree. Don't rush yet... A segment from a contract for the purchase of an apartment from a contractor:

Section 24.1.1 states that the contractor does not want any dealings with other buyers before receiving full payment. Let's assume we've convinced the contractor to waive this clause. The next section, 24.1.2, mentions that the contractor himself is not truly the sole owner of the apartment he built. As long as construction is not completed and the full payment for the apartment has not been made, a lending bank is also involved on the property, and it would need to agree that instead of providing a guarantee for one buyer, it would now become a guarantor for the funds of two different buyers. Even if the contractor agrees, this agreement does not bind the lending bank.

Anyone entering into this deal is already in a bind because they need to convince the lending bank. Let's assume they succeed. Is their path to the 200,000 shekels guaranteed?

Not so fast...

If the buyer has 2.3 million in cash, there is a chance the deal will work. Most buyers will want to take out a mortgage to close the deal. The bank that is supposed to give them a mortgage will see an apartment with the following rights holders:

1. The entrepreneur.
2. The entrepreneur's lending bank.
3. The original buyer.
4. The new buyer.

Furthermore, the bank providing the mortgage would have to pay 2.3 million shekels, even though the bank guarantee covers only the original purchase price of 2 million shekels. It is highly unlikely that a bank would agree to provide a mortgage for such a transaction. Without a mortgage, it is unlikely that a buyer will come forward. If the original buyer has the option to cover the remaining 1.8 million shekels through a mortgage or by any other means to complete the transaction and receive the apartment, it’s half the trouble. It wasn’t the plan, but at least they won’t lose money. But… if, for whatever reason, the buyer is unable to complete the transaction, they will breach the purchase contract and pay the contractor a breach fee of approximately 10%, and will also be liable for a lawsuit in addition to the 10%. In other words, someone who enters into a deal with 200,000 in the hope of becoming the proud owner of 400,000 at the end of the process is highly likely to end up with zero shekels at the end of the process.

Watch your wallets.