Some Upside In Failed En Bloc Deals

Source : The Business Times, April 15, 2008

LOOKING for a silver lining when nothing looms but storm clouds may seem a futile exercise.

But recent events surrounding the failed collective sales of Tulip Garden and Makeway View to Bravo Building Construction may just be a ray of hope in an increasingly gloomy property market.

To be sure, when Bravo decided it could no longer proceed with the collective-sale deals, some considered it yet another in a series of ominous events signalling the end of 'irrational exuberance' in the property market here.

Another was the pullout of Kuwait Finance House from a deal to buy 97 units at Goodwood Residence.

But putting a positive spin on the failed deals, Bravo has actually helped the market by withdrawing almost 400 potential units from future supply. If the Bravo deal to acquire another en bloc site (Pender Court) falls through, the number of potential units removed from future supply could be closer to 500.

This may be less than 3 per cent of the 17,800 new units CB Richard Ellis estimates could be launched this year, but if more developers were to follow Bravo's move, enough potential units could be removed from the future market to mitigate a more serious oversupply situation - especially in the light of drastically falling sales; only 185 new private homes were sold in February.

Emergency exit

Any developer considering the emergency exit that Bravo took will have to ask itself - as Bravo probably did - whether it has the holding power to build and hang on to units until it is profitable to sell them.

Perhaps the pivotal number to emerge in the failed Tulip Garden deal is the $25.8 million figure representing the 5 per cent deposit on the $516 million transaction that Bravo will now forfeit.

While $25.8 million is no small sum to lose, it is probably less than what Bravo could have lost had it proceeded.

Based on a loan quantum of 60-70 per cent of the land price, the loan for the Tulip Garden project would have amounted to $310-$360 million.

While it is not unusual for a bank to extend loans to preferred developers at interest rates close to Sibor, an interest rate of 5 per cent per annum would have been more likely, considering the times. In which case the cost of the loan could have been between $15.5 million and $18 million for the first year alone. This, also allowing that banks still feel comfortable extending loans of over 50 per cent.

Another loan the developer would have had to take would have been for construction costs. And based on a cost of $400 psf, this would have amounted to about $200 million for the Tulip Garden project. The quantum a bank will lend a developer varies. Assuming Bravo were to have taken a 50 per cent loan, the cost of this would have been around $5 million for the first year based on a 5 per cent interest rate.

Bravo's interest payments for the first year could have totalled $20.5-$23 million.

Developers do not generally borrow more because they expect progress payments from the initial sale of units, which go into a project account, to cover some of the costs.

But falling sales volumes would have made it difficult for Bravo to depend on the project account to finance construction.

Lower selling prices would have been a concern too.

Breaking even

When the market was at its most bullish last year, Bravo had hoped to launch the new development on the Tulip Garden site at around $2,000 psf.

However, the US sub-prime crisis has taken its toll on the market, with neighbouring developments Duet and The Cornwall peaking at around $1,500 and $1,700 psf respectively last October.

It was estimated earlier that Bravo would have to sell all the new units at Tulip Garden for at least $1,500 psf just to break even.

Developers who are likely to be swayed by this line of reasoning to reconsider developing en bloc sites are more likely to be the smaller, newer players in the field.

Based on available data, an estimate by Savills Singapore puts the number of new units from en bloc sites bought by construction companies in 2007 at more than 800, excluding Tulip Garden and Makeway View.

If some of these potential units were to be removed from the future market, supply pressure would be eased.

It would, of course, be much simpler if the potential units from a large en bloc site like Gillman Heights or Tampines Court were removed from the market.

But this is unlikely as it has become almost a mantra that big developers have holding power, even if they are losing money at the same time.