An overview of the construction of residential neighborhoods on debt

Introduction

In recent years, the housing construction sector has grown exponentially in Bucharest, despite the multiple crises that have led to an increase in housing prices. According to the Romanian National Institute of Statistics, the price of construction raw materials and iron increased by 40% in 2022. Despite this increase in construction costs and consequently in sales prices, there are many offers for the sale of real estate, supported by a strong demand on the market. More Romanians are prioritizing buying a home as part of managing their savings. In this economic environment, real estate developers continue to build homes either with money borrowed from banks, which is increasingly the case, or with funds received in advance from buyers.

 

Financing residential projects

Even the largest real estate developers, with significant equity capital, choose to build residential projects with funds from multiple sources. Funding typically comes from two main sources:

• purchase agreements with buyers of future properties
• mortgage loans from a bank

 

Selling residential buildings before they’re built

In this case, the buildings are only shown on the architect's plan. This type of transaction is legally regulated under the name of "sale of future assets."

As a general rule, when buying a future asset, the parties conclude a pre-sale-purchase agreement where the buyer pays an advance of the price. The transfer of the ownership right happens when the parties conclude the sale-purchase agreement authenticated by a notary public. At the moment of authentication of the sale-purchase agreement, the construction must be completed and registered in the land register, otherwise the sale-purchase agreement cannot be concluded.

This is a regulation aimed at protecting the buyer from possible risks if the property isn’t completed. For example, the law provides that the risk of accidental loss of the property remains with the seller (real estate developer), so the seller has to return the money received from the buyer if it’s not able to deliver.

According to the Civil Code, the property is deemed to have been built on the date on which it becomes fit for use in accordance with the purpose for which the agreement was concluded. But construction regulations supplement the provision, requiring completion minutes concluded with the authorities and the issuance of an edification certificate. On completion, the development must fulfill all the specific functions of a building intended for residential use. The property must be connected to all utilities such as water, sewage, electricity, heating, and have essential finishes such as doors, windows, plumbing fixtures, tiles and flooring.

Selling apartments before they exist is a common practice in the Romanian real estate market. The explanation lies mainly in the imbalance between supply and demand in the market. The main advantage for the buyer in this type of purchase is the price of the property, which is usually much lower than the price set by the developer once the residential project is completed. The low price reflects the buyer’s assumption of risks, namely: delay in the completion of the residential project, insolvency of the developer, and non-conformity of the completed property compared with the one presented in the initial project.

But it’s possible to mitigate the risks by including specific contractual clauses. For example, late payment penalties can be negotiated with the developer in the event of a delay in the completion of the project. To prevent the risk of the developer’s insolvency, additional guarantees can be stipulated for the repayment of the sums paid, so, in addition to the developer, third parties can undertake to be liable to the buyer.

 

Mortgage loans are another way to finance residential projects

Romanian real estate developers (Romanian legal entities) can get a mortgage loan which is strictly intended for the construction of buildings.

According to the Civil Code, a mortgage is a real right over movable or immovable property created to guarantee the performance of an obligation. The mortgage is, by its nature, indivisible and an accessory. It subsists as long as the obligation it secures exists (to repay the loan and the interest in full), and it’s fully enforceable over each encumbered asset and each part of the asset, even in cases where the property is divisible, or the obligations are divisible (in this case, the obligation to pay the borrowed money is a divisible obligation).

For real estate developers, the loan granted is made available gradually, depending on the progress of the construction work on the real estate project. On completion of the construction, once the construction certificate, the report of acceptance of work and the registration of the construction in the land register are obtained, the mortgage in favor of the bank, which was initially taken only on the land, will extend to all the constructions of the residential complex.

Once the real estate developer has completed the construction work and obtained all the necessary documents for the registration, and once the mortgage has been extended to all constructions of the residential project and the building furnished, the developer can start selling the buildings. For this stage, it’s mandatory to obtain a written agreement from the creditor bank.

This agreement must contain a favorable opinion to the disposal of the building and the release of the mortgage for the sold unit. It must also include the conditions under which the sale is concluded and the account to which the price paid by the buyers will be transferred. All the money obtained by the developer from the sale of the constructed property will be transferred to the account of the creditor bank for the settlement of the loan. Once the loan is paid off, the developer will be able to sell the remaining assets and collect the sale price of the assets on their own account without having to get the bank's agreement.

 

Foreclosure of the mortgage

If the real estate developer fails to complete the residential project and is unable to pay the creditor bank, the latter will proceed to the execution of the mortgage. The seizure of the property will be registered in the land register, and the property (land and buildings) will be sold to recover the mortgage amount. The legal mechanism for the recovery of the mortgaged property is public auction. In the foreclosure procedure, the only objective is to obtain the remaining amount to be repaid. So even though 90% of the debt might have been paid, the bank can sell the entire mortgaged property to cover the remaining 10% debt. Essentially, a valuable asset could be sold at a price well below market value. In contrast to this situation, if the sale of a property is negotiated in the course of an ordinary sale and purchase agreement, setting the price of the property at 10% of its real value constitutes tax evasion and the contract is not validly concluded, which means that it can be cancelled in court by the interested party.

The repayment period of a mortgage loan can range from 3 to 35 years, with partial or total early repayment possible at the developer's request and with prior consent of the bank.

 

Conclusion

Developing residential neighborhoods without allocating the real estate developers’ financial resources has become common practice in Bucharest. But both sellers and buyers must be carefully analyze the risk beforehand and prevent it by negotiating well-defined contractual clauses. This applies to both the developer's relationship with the lending bank, and in the sale contracts concluded with buyers.