You will hear lots of common phrases in the property industry and one that has become widely used in recent years is interest on deposited funds. So what exactly does it mean?
It certainly sounds good when you see it on an advert for investment property. You would be forgiven for thinking that interest on your deposited funds means a nice little bonus while you are waiting for completion. In some case this might be right and even better, if there is a short lead time from the start of construction to completion, you will benefit from some extra peace of mind.
The reason you are seeing more and more deals offering interest on deposited funds is linked to the demand for investment property, which has seen a dramatic increase over the last 12 months – particularly in UK cities north of London. While this demand is certainly welcome, developers in some of the more popular locations are struggling to keep up and bring new products to the market fast enough while they are still building and completing existing projects.
The situation has become so acute, we have seen even some of the larger developers hold off on new instructions in order to catch up.
With many “London investors” now looking for value in the north, the construction companies covering northern cities don’t know what’s hit them and this has seen project lead times on major projects increase.
In fact, most of the new products on offer have a minimum 18-24 month build time.
OK, property investment has a lot to do with risk/reward but for me, projects with long build times present the highest risk of all and we try to avoid these unless they are particularly special and offer significant capital growth for low exchange deposits.
Bank lending charges for developers are extremely high, so to make the investment more attractive to investors, developers have recently been offering investors interest payments on their money. This has been used to help them secure early sales and secure finance requirements to get developments “off-the-ground”. Now this can be mutually beneficial, and in most cases it is but investors should also beware that this “return” will generally be factored into the sale price. OK, its common sense as the money must come from somewhere and in the right area with the right property, the cost of this will be drowned out by good capital growth anyway.
Unfortunately, when interest on deposited funds is payable on developments in areas where capital growth may not be as certain, I still see it as a trick of the trade. In these cases it only assists in blinkering the investor and providing them with a “return” which they are effectively funding themselves.
My advice here is to consider the reasons why the seller is offering interest on your deposit and calculate the risk against more important factors such as growth, developer reputation and their track-record.