What is Deferred Consideration?

deferred consideration property developmentWhat is Deferred Consideration?

The concept of deferred consideration is quite straightforward in that a fixed sale price has been agreed between buyer and seller with part of the price is not being paid at completion, it is instead deferred until a later date. The consideration given for the purchase has been deferred.
It may seem like something that occurs once in a blue moon but it is more common than most people realise, especially when it comes to property developers and purchasing property to be developed.

Property Developers & Deferred Consideration

For many developers the use of deferred consideration works really well. Think about it.

The big concern for most property developers is cashflow. Deferring all the purchase price until the site is finished or paying part of the purchase price on completion and deferring the balance of the purchase price to a later point in time means the developer can put the purchase capital into the development, rather than on day one at purchase.

The challenge comes with financing this type of development deal because the ownership isn’t straightforward, but it can be done.

If the seller agrees, the lender will have the first charge on the development property/ land with the current owner (the seller) then having a second charge to ensure they retain an interest in the land, after all, they have yet to be fully paid for it. The lender will then use the development value of the site as security and advance funds to the developer for the build. Once the development is complete, it is sold or refinanced, the lender is repaid and the seller gets the balance of the purchase.

Let me give you an example of how this works:

Example Transaction

  • The developer needs to borrow £1.5m
  • This is £900,000 to purchase the site which has planning approved for 6 houses
  • £900,000 required to build the 6 houses (being £150,000 build cost each, expected sale value of £400,000 per house, being a total GDV of £2,400,000)

Traditionally the developer would be putting in his own cash on day one and financing the rest.

Now, let’s assume deferred consideration:

  • Instead of selling for £900,000 the seller agrees to sell for £950,000 plus 10% of the profits
  • The developer only needs to borrow £900,000 for the cost of the build, so their finance costs are lower
  • On completion the seller gets £950,000 plus 10% of the profit, being £55k

Why it works

  • On this basis the developer saves interest because they are only borrowing £900,000 not £1,500,000
  • The developer also has the capital they would have been paying away on day one to cashflow the build and cover overruns
  • The seller gets £105,000 more than they would have received

The use of deferred consideration isn’t for everyone and not every seller wants to wait until the end to get their money, but where both parties agree it can work well. Plus, you can finance this type of development structure so don’t be put off.

If you want more details or you want to see how to finance your development project then get in touch.

DAVE FARMER

 

 

 

By Dave Farmer

 

 

 

 

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