Residual stock loans: what we've learned from the deals we've looked at

If you've finished a development and you're still holding stock, the construction loan doesn't care that the market has slowed. It has an expiry date, and once practical completion is reached most construction lenders want to be repaid. A residual stock loan refinances that debt against the finished lots so you can keep selling without having to discount everything at once.

We've looked at a steady run of these since we opened, and the same handful of issues come up every time. The examples below are based on real enquiries, but the numbers and details have been changed so none of them can be identified.

How a residual stock loan is sized

A lender looks at three numbers: what the unsold stock is worth today, what you owe the construction lender, and how much interest will build up while the stock sells. The loan has to cover the payout plus capitalised interest and fees, and it has to do that inside the lender's LVR limit. If it doesn't, the gap has to come from somewhere, which usually means more security or cash from the developer.

The part people underestimate is the capitalised interest. On a 12 month loan it can easily be 10% or more of the loan amount, so a deal that looks fine at 70% on day one can be tight once you add a year of interest.

Example one: the appraisal and the valuation don't match

A developer with a small group of completed townhouses in a regional market asked for about $9 million to refinance their construction loan and release some equity for their next project, at a little over 70% of the end value they'd been given.

The structure made sense, but the value didn't hold up. The figure came from an agent's appraisal that sat well above what similar stock nearby was being listed for, and the local market was taking months to sell. Regional locations also attract lower LVR limits from most funders, and releasing equity before a valuation had been done was premature. A refinance-only loan sized off a proper valuation was possible, but the cash-out wasn't, unless the developer could add other property as security.

The lesson: an agent's appraisal gets a conversation started, but the loan is sized on the valuation, and if the appraisal is well above the comparable sales you should expect the loan to come in lower.

Example two: a second mortgage behind the construction lender

A developer in a capital city had a few unsold apartments left and a non-bank first mortgage that wasn't going to stretch any further, so they needed a second mortgage to cover a shortfall.

A second mortgage works here as long as the senior lender is a bank or an ADI-grade lender, the first mortgagee agrees to it, and the combined LVR stays inside what the funder will accept. We don't take second mortgage positions behind other private credit funds. In this case the senior loan needed to be reduced slightly and the developer had to find a small amount of cash elsewhere, but it gave them a path to sell the stock over 12 months without a fire sale. We also pointed the broker to another lender who could go higher, because the goal was to get the client funded, not to win the deal at any cost.

The lesson: a second mortgage behind the construction lender can be quicker and cheaper than refinancing the whole lot, but the first mortgagee has to be on board, and the total LVR is what everyone looks at.

Example three: terms issued, deal lost

We issued terms on a larger residual stock facility and the developer went with another lender. It happens, and it's a good reminder that developers should get more than one set of terms on these, because the structures vary a lot more than the headline rate suggests.

What makes a residual stock deal easy to fund

• Titles registered and occupation certificate issued. Until then it's still a construction risk, and most residual stock lenders won't touch it.
• A realistic price list. Valuers will look at what's actually sold in the building and nearby, so pricing that's already been tested by the market helps.
• Some sales already done. It shows the stock can sell and it lowers the loan balance.
• Partial discharge amounts agreed upfront. Each lot settlement repays a set amount, so everyone knows where they stand.
• A clear exit. Sales first, and a refinance of the last few lots to a bank or cheaper lender as the backup.

What to ask any lender before you sign

1. What valuation basis are you using, as-is in one line or individual lot values?
2. How much interest will be capitalised, and is there enough room for it inside the LVR?
3. What's the release price per lot?
4. What's the minimum term, and what happens if I sell everything early?
5. Is the first credit answer the final one, or will terms change after the valuation?

If you've got stock left at the end of a project and a construction lender asking questions, send us the scenario and we'll tell you quickly whether it works and how.